In the second of two articles looking at the development of captive insurers, long-time risk management expert Alan Fleming reflects on recent captive innovations he was involved with.

Much of my captive involvement occurred during my 29 years at Imperial Chemical Industries P.L.C., but not all of it; I continued to expand my involvement with captives in subsequent risk management, brokerage and association roles, as well as becoming one of the few captive regulators to come from the risk management profession.

I joined Guinness P.L.C. as head of risk management in 1995. Guinness already had an established captive when I arrived, but we instituted significant increases in captive retentions, resulting in savings for the company.

Guinness had earlier established a broker subsidiary in Sark, in the Channel Islands, which are U.K. dependencies off the coast of France, with a goal of pulling together data and information from around the world to establish a global insurance program and to control and recapture commissions from insurers on its risks. Guinness subsequently established its captive insurer in Guernsey in the early 1980s, motivated by similar issues as those behind ICI's captive.

In 1997, Guinness merged with Grand Metropolitan P.L.C. to create Diageo P.L.C. Guinness' established captive, risk management strategy and directors and officers liability initiatives resulted in Guinness being very influential in the ongoing risk strategy of the newly combined company. The businesses of Guinness/Diageo were a change for me, including beer, spirits, the restaurant chain Burger King and food products company Pillsbury.

Today, as a board member of the Diageo captive, I know that Diageo senior executives continue to see the captive adding value to the business. Apart from savings in what would be external insurance costs, they view the captive as a uniting influence for management of operations throughout the world. Diageo is a global business and nearly all its operations around the world are insured by the captive.

There are significant retentions in the captive on the property and consolidated loss program — £50 million ($75 million) for any one loss — and significant but lesser retentions on the liability classes, which have a longer tail. The captive has influenced the breadth of coverage and the market has cooperated.

Diageo realises that many of its local businesses want to protect themselves against unexpected volatility. The captive provides this protection through coverage for risks that are acceptable to the consolidated group but would be potentially damaging to local profit centers. One example is advertising promotions where cancellations of events due to adverse weather conditions could be very damaging to local businesses but acceptable in an overall group perspective.

In addition to allocating premiums to Diageo's insured operations, the captive retains significant funds to apply at its discretion for risk improvement or risk monitoring. This has been used to provide catastrophe modelling and an analysis of options in the event of unexpected catastrophe losses. Recent flood losses in Thailand and Australia, for example, were unexpected and the captive subsidized risk engineering options that were not strictly covered by the insurance policy and may not otherwise have been possible for those local operations.

More recently, Diageo's captive started to provide reinsurance for a global employee benefits program. This has provided not only savings to the company but also a significant improvement in the control of its management data on these risks.

Railtrack

In 1999, I was appointed head of insurance and risk management at Railtrack P.L.C., which was responsible for railway stations and infrastructure after the 1994 privatization of the British rail system. Railtrack included several different operating companies.

After joining Railtrack, I conducted a detailed review of captive feasibility for the organization, which had established a captive in 1996, but until then had limited its usage. Although there were limited tax advantages for the captive, the board accepted my argument that the captive was a valuable risk management tool.

In the process of evaluating Railtrack's captive we discovered in excess of £20 million ($30 million) in unreserved liabilities, particularly for employer's liability losses. With the help of the captive, Railtrack was able to avoid the heavy financial burden of realizing those unrecorded liabilities on local operations.

At the same time, the captive improved the company's risk database. With rail operations located across the country, consolidation of information was important, and significant risk improvements resulted from a comparison of claims results between regions and entities.

The captive also provided important advantages to the company beyond risk financing in the wake of major railway accidents. Within an 18-month period, there were three fatal train crashes, with multiple casualties and costing the company many millions of pounds:

The Ladbroke Grove crash occurred on Oct. 5, 1999, when two passenger trains collided at Ladbroke Grove in West London, with 31 people killed and more than 520 injured.

On Oct. 17, 2000, a train derailed near Hatfield, England, and caused four deaths and injured 70 people.

On Feb. 28, 2001, a train collided with a car towing a trailer that was on the rails at Great Heck near Selby, England, causing the train to derail and resulting in 10 deaths and more than 82 people seriously injured.

The U.K. rail industry has a legal commitment to a dispute resolution process for third-party claims, called the Claims Allocation and Handling Agreement that all insurers of railway companies must follow. The agreement requires that when an incident occurs one party is chosen to deal upfront with the consequences of the incident and claims.

This coordination saves millions of pounds in legal fees and means that quick action can be taken to resolve claims. Any disputes among insurers and insureds as to allocation of responsibility are heard only once compensation is made, often through mediation.

Through Railtrack's captive involvement, the company's board gained access to information from major claims decisions that it might not otherwise have obtained.

Following the Hatfield crash, Railtrack adopted risk mitigation programs, such as imposing lower speed limits countrywide after the Hatfield crash to improve rail safety. This decision to limit speeds had an enormous cost effect on the company, much greater than the financial recovery for damages from insurers. Railtrack was required to compensate railway operating companies for any delays caused by its actions. However, this cost would not be covered by insurance and it was important that the board realize this before they made the decision to proceed.

After those three major losses, Railtrack's insurers were very defensive and threatened to withdraw coverage. After two days of intense discussion with Swiss Reinsurance Co. and an increase in the captive retention to £50 million ($75 million) per claim from £5 million ($7.5 million) we were able to get insurers to continue to provide coverage.

Having a captive insurer also allows transport companies such as Network Rail — which took over Railtrack in 2002 — and Transport for London, which governs public transportation in greater London, to gain direct access to terrorism reinsurance coverage through Pool Re.

My time as a regulator

In 2003, after serving as chairman of the U.K. risk management association Airmic and two years as a strategic account manager at Aon P.L.C., I accepted the position of director of insurance regulation in Guernsey, a leading domicile and home to many U.K. company captives.

I succeeded Steve Butterworth, who initiated the Protected Cell Company captive structures in Guernsey, and I was privileged to serve at a time when there was considerable growth in the captive business. I reviewed many interesting captive and PCC initiatives. I also had the opportunity to meet and discuss with senior corporate representatives from the parent companies the vast majority of which were very positive about the performance of their captives.

One of my main duties as a regulator was to represent Guernsey in the International Association of Insurance Supervisors, and I attended many technical and subcommittee meetings of the IAIS. It was obvious to me that there was little understanding of captive insurance among the insurance supervisors in the association.

With support from other offshore captive jurisdictions and regulators from the United Kingdom, Singapore, Canada and Australia, I was tasked with producing an issues paper on captive insurance that would inform the wider IAIS audience about the role of captives, which could lead to more specific regulatory guidance. I chaired a working party that produced this issues paper, which was accepted at the IAIS meeting in Beijing in 2006, and prompted agreement for a subsequent guidance paper on captives to be prepared.

More recently

At the end of 2006, I stepped down from my regulatory role and stepped into the role of interim CEO of Airmic until January 2008. Today I continue to be involved with the U.K. risk management association as chairman of Airmic's Captive Special Interest Group.

Through my Airmic connections I have been working with Valerie Alexander, UK head of corporate insurance for Deutsche Bank and an officer of the European Captive Insurance and Reinsurance Owners' Association. Together we have held several number of joint meetings with U.K. regulators to try and influence proportionality with regard to how they apply Solvency II requirements to captive insurers. The captive is highly valued by Deutsche Bank management, according to Valerie. The captive also has helped the company optimize its insurance purchases, which allow it to mitigate its operational risk, mapping insured risks against the risk categories that banks must follow under the Basel II accords. Thus, the captive has assisted the company to reduce its operational risk capital charge.

I have also recently been working on a project with Judith Hanratty, formerly company secretary and head of insurance for BP P.L.C., and Jonathan Bates, who was a member of a team advising the chairman and board of BP on fiduciary decisions from 1994-2000. In the 1990s, they were instrumental in BPs decision to exit the commercial insurance market. As part of its retention of risks, BP combined several legacy captives it had inherited through acquisitions into Jupiter Insurance Ltd., which is now the largest captive in Guernsey. Jupiter serves BP's insurance needs globally and also provides coverage for statutory classes of coverage where required. In a 2009 review of the initiative to stop paying for commercial insurance, BP determined that the strategy had added $3.5 billion of value since it was adopted in 1991.

Today, I am also involved as a nonexecutive director of two mutual insurers in the United Kingdom, and two single-parent captives in Guernsey, including the one owned by Diageo.

I also serve on the board of a Hong Kong captive whose business is the transport and storage of very high-value products such as platinum and gold. The company historically was fully insured by underwriters at Lloyd's of London before it realized the potential for sensible self-insurance as part of its risk financing. The company capitalized its captive about six years ago at £250,000 and today capitalization stands in excess of £15 million ($22.5 million).

The company has had serious losses, such as a diamond heist at the Brussels airport, which was insured by Lloyd's underwriters above $2 million retained by the captive. But the captive also has significantly improved the company's premium negotiability and also support the parent on business expansion by investing excess captive funds in new warehouses.

Alan Fleming, based in the United Kingdom, is a former risk manager, insurance regulator and risk management association chief. This article was written with the support of Hugh Rosenbaum, a retired principal of Towers Watson and editor-emeritus of Captive Insurance Company Reports, published by the International Risk Management Institute. He also is one of the founders and organizing partners of the World Captive Forum.