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CAPTIVE INSURANCE Managing Mining Risks Using a Captive Insurance Company Mine operators often have a clearer grasp of costs and risks than large insurance companies. Why not put that knowledge to work for more cost-efficient risk management? By John G. Nevius, Esq., P .E., and Phillip England, Esq. Mining is risky. Effectively managing risk can make the difference between running a successful mining operation and going bust. Many risks can be quantified and managed routinely, such as employee injury through Worker's Compensation programs. Some risks can be quantified, but remain hard to manage, such as fluctuations in commodity prices. Financial assurance with respect to potential environmental liabilities or reclamation-and-closure obligations can be both difficult to quantify and hard to manage. Utilization of captive insurance is one way to lessen the impact of these elements of risk, to a mining company's advantage, or, at least, to bring increased financial sophistication and a measure of control to a traditionally unpredictable set of mine-operation variables. Part 1 of this article provides basic information on what a captive insurance company is and why a mining business would want to establish its own captive(s). Part 2 provides greater detail on the necessary steps to establish a captive and key considerations when doing so. Parts 3 and 4 then provide a more-detailed analysis of relevant tax and legal issues, respectively, for those who want to know more. Whether a captive is right for a business at this stage in its development depends on both objective and subjective determinations. Everyone, however, should understand the basic principles involved. At some point many large businesses, both publiclyand privately-held, embrace the use of a captive. This article focuses on practical steps and more-traditional uses of captives. However, these are just guidelines. Captives can be used in myriad ways and can be especially advantageous when used creatively, depending upon the specific business and risk circumstances. Moreover, most people evaluate captives from a tax perspective, but, as discussed in more detail below, this is only one potential advantage. Accordingly, even if a captive did not seem to make sense in the past or 36 E&MJ; • FEBRUARY 2013 is not presently an attractive choice, a captive likely will be advantageous from a different perspective or at some point in the future. Business partners and competitors likely are already using one. What is a Captive Insurance Company and Why Have One? A captive insurance company is an entity formed under the law of a particular jurisdiction (domicile) primarily to insure or reinsure, and better manage the risks faced by one or more corporate parents or related entities. Properly structured and administered, captives can provide significant cost savings over more-traditional commercial insurance coverage. An important portion of those savings arise from the special tax regime applicable to insurance companies. However, captives can pay for themselves simply through the more effective management of risk at an individual operation or company. Captives also can be used to insure the risks faced by unrelated entities in the same industry such as different mine operations in what is commonly referred to as a pooling arrangement. Previously under-insured environmental and other related risks, such as those associated with milling and refining, underground operations or reclamation, also may be pooled using a captive as well. In essence, a captive serves as a funding or financing vehicle for self-insuring the losses of the related organization that fall within a specific retention level designated by the parent which may be greater than in the conventional coverage program. In other words, by taking greater responsibility for managing more modest losses, captives can save money by avoiding or reducing premiums paid to outside commercial insurance companies. Moreover, by retaining a higher designated level of risk, funded by the captive, not only may substantial savings be achieved by both lower commercial-carrier premiums and tax planning, but also from more efficient and effective risk management at all levels of an operation. Part of the potential savings can arise by virtue of having a skin in the game, so to speak. Companies that embrace substantial self insurance programs send a message to commercial insurance companies that they are serious about managing risks and costs and should, as a result, save on basic premiums. At the same time, these same companies should be able to acquire a larger amount of more higher-level excess (or "wholesale" reinsurance) coverage at a reduced cost. When accepting a greater level of risk, captives apply the same principles as are applicable to evaluation of other traditional programs to save on premiums such as proposed deductibles, so-called self-insured retentions or retrospective premium programs. Many companies tend to avoid risk retention and prefer to outsource risks such as Worker's Compensation. Most companies manage risks through the purchase of various primary insurance policies to directly protect property, or officers and directors, or to offset losses from casualties, lawsuits and errors and omissions, etc. By taking more direct control of risk management generally, and by using a captive, companies can also manage or assert greater control over insurance responsibilities such as risk assessment and claims handling. This, in turn, should allow a mine operator to achieve substantial additional control over outcomes in the event of a loss. Embracing risk management in-house has other potential advanwww.e-mj.com