Engineering and Mining Journal - Whether the market is copper, gold, nickel, iron ore, lead/zinc, PGM, diamonds or other commodities, E&MJ takes the lead in projecting trends, following development and reporting on the most efficient operating pr
Issue link: https://emj.epubxp.com/i/109221
CAPTIVE INSURANCE tages, such as avoiding disadvantageous arbitration of claim disputes, reducing claim denial and lowering inflated premiums. A captive may be owned by a corporation or by non-corporate entities and can be domiciled onshore or offshore. The domicile will determine how the captive is regulated. Providing all of a captive's actions are deemed prudent and within the scope of the captive legislation, it can "write" almost any line of insurance for related or unrelated entities, and charge a premium that the company and the regulators (of its domicile) find acceptable, with reference to applicable actuarial and loss projections. All decisions regarding the operations of the captive are made by its board of directors. Directors are elected by a captive's shareholder-owners, including policyholders or owners of policyholders. This ensures the owning company(ies) maintains control of the captive's operations and permits the captive to be as aggressive or conservative as desired with respect to the level of risk retention. It is important to keep in mind that a captive, as an insurer, is subject to all of the applicable laws and regulations of its domicile. Consequently, legal counsel is essential at the establishment of a captive and from time to time thereafter during operation of a captive. However, the heightened level of control and access to a broader array of riskmanagement options leading to lower cost coverage, make captives an attractive option for mining companies seeking more control and greater flexibility when it comes to risk management, including procurement of financial assurance. Captives also allow mining operations to achieve potential tax savings, as well as greater control over dedicated funds (i.e., those funds set aside for reclamation and closure). Embracing a captive is all about taking more control over how a company's affairs are managed. It represents a significant step forward in, not just control, but financial sophistication. When is a Captive a Good Idea? Setting up a captive takes time and requires both upfront and ongoing allocation of resources. Accordingly, tax concerns should come second to the basic business purpose(s) of a captive. Although there are tax advantages that can be achieved with a captive, the initial premise and motivation for a captive must be non-tax. A captive insurance policy should use market premium data to establish rates on an "arm's length" basis. This means that a captive can accrue for loss expectancy for www.e-mj.com currently unknown liabilities on the same basis as an independent insurance company. In fact, mine operators and their consultants often have a clearer grasp of mining costs and risks than large insurance companies that do not necessarily specialize in hard rock mining. The major difference from commercial coverage is that the premium dollars do not simply come under the control of a third party. With traditional insurance, a thirdparty insurance company earns interest on premium dollars, retains them when there is no loss, and may refuse to distribute them fully or properly in the event of a valid claim. Third-party insurance companies have limited incentive to pay claims generally or in full and have been known to pursue implicit or explicit claim-handling policies of forcing policyholders to litigate large claims—especially when the liabilities involved are "environmental." The commercial insurance market may firm or soften over time when it comes to coverage availability. A parent company and its risk group can adjust to these market conditions by forming a captive to: (i) fund potentially higher retention levels, (ii) build strategic relationships with insurance markets, and (iii) reduce cost of coverage during a period when the market is up. Thus, companies can save considerably on premiums by agreeing to absorb a greater initial portion of a loss. This, in turn, can reassure third-party insurance companies by reason of their policyholder having a greater incentive to control losses; i.e., by having more skin in the game. By being more involved in managing initial risks and procuring excess insurance that incepts at a higher level, the captive's owners expand opportunities for developing strategic insurance market relationships. In addition, by appropriately domiciling a captive, relationships with government regulators of insurance and environmental financial assurance may assist the mine operator in managing the amount of cash or letters of credit necessary to collateralize either loss reserves or financial-assurance bonds. In other words, the overlapping government regulation should serve as reassurance that appropriate resources have been committed and are properly in place to meet bonding, or claim payment obligations. Moreover, companies that have captives demonstrate to insurance markets that they are comfortable with the risks they face, through their willingness to retain that risk. In fact, the very existence of a captive can provide negotiation leverage for better premiums and coverage terms within the commercial insurance marketplace. All organizations face risks of negative events or conditions that are expected to occur over time, but the events are unpredictable in terms of exactly when, and to what extent, they will surface. Should the risk of a catastrophic event need to be managed, a captive providing the primary coverage would have the option of accessing reinsurance markets for a finite-risk reinsurance program. In other words, a captive can be used to gain access to reinsurance markets in a manner which can be thought of as akin to purchasing higher levels of insurance at wholesale prices (obtaining reinsurance is also a standard means by which commercial insurance companies balance their own risk profiles in managing their own risks). The foregoing summarizes a number of reasons why formation of a captive can advance business objectives as an integral part of a company's or a group's strategic planning. The next step in this description of the captive process is to explain certain components of the feasibility study, which a proposed captive would need to undertake as an initial step in order to confirm how the captive will address the various needs of its owners. That feasibility study will review the nature of coverages to be written; range of premiums rates based on actuarial studies and loss history; administrative costs; tax planning; cost of sunk capital; choice of domicile and regulatory environment. We will review several of these elements below. Getting Started There are well over 4,000 active captive insurance companies worldwide, nearly 1,500 of which are domiciled in Bermuda. Vermont, the largest U.S. domicile, has nearly 500 active captives. There are a number of other potential captive domiciles, although these two dominate. Also, it FEBRUARY 2013 • E&MJ; 37