The Social Benefit of Captive Insurance Companies: Changing People’s Lives

Not a topic that you’d perhaps be expecting me to write about.

However, it’s a topic worth commenting on. The rapid growth of the captive insurance company movement in the 1980s and 90s was a direct response to prevailing market forces and the absence of coverage. The captives formed then and still in existence have stood the test of time and are now in an advanced state of underwriting maturity, and with that maturity has grown an increased wisdom about the reality of the social benefits of captives.

Mature underwriters are known for their expertise in controlling losses…and some of them for their expertise in making people’s lives safer and more productive.

So let’s start with Zachariah Allen.

Not many people these days are familiar with Zachariah Allen. His name never comes up at captive industry conferences. No scholarship benefiting a professional in the captive industry bears his name (not yet anyway). But to be clear…Zachariah Allen is the father of the captive movement in America.

For it was in 1835 that Allen, dismayed by the renewal invoice he got from his insurer providing what was then pretty close to a modern day all-risk fire policy covering his mill in Rhode Island, asked his insurer for a break in premium in return for the significant fire loss control measures he had put in place.

In those days, mills were built of wood…this was long before the brick mills that I as a kid in New England grew up living near. Wooden mills burned to the ground with alarming frequency. Businesses were shut down. People’s lives were lost. Allen couldn’t get his insurer to listen to him. He was told pretty clearly that what he had to say was not new, not innovative, and not helpful. Unfortunately commercial insurers sometimes in our own day still respond to their insureds in this dismissive way, which is, of course, one the reasons why captives exist to begin with.

But Allen was an enterprising man. He decided to form his own insurance company. He decided to put his well thought-out plan to control his exposure to loss to the ultimate test by using his own capital. It’s nothing more nor less than what continues to happen in 2018 every time a captive applies for a license.

But Zachariah Allen was the first. He formed America’s first captive.

Of course, Allen was a businessman; his first concern was for the protection of his property and his business. But let’s also be clear that while he was busy doing that, he was also saving his workers’ lives. The first example of an American captive becomes, at least on a de facto basis, the first example of a captive providing a direct social benefit.

And before I forget to mention it, Allen’s captive is still with us. Of course, it looks a little different today than it did in 1835. It’s now known as FM Global.

Let’s move on to December 2001. The St. Paul exits the medical professional liability marketplace. To be candid, given the St. Paul’s claim experience in this class in the late 1990s, their exit was inevitable. However, their departure, as one of the preeminent sources of physician and hospital medical professional liability insurance, sent a shock wave through the marketplace. This was the last and the worst hard liability market. I’ve lived through three quantifiable hard markets in my time. I know a hard market when I see one. (And, by the way, nothing I see operating in the marketplace today signals that we’re even close to having another one, contrary to the wishful thinking of the commercial marketplace.)

A story that has never been written is the story of what happened to the marketplace in 2001 through 2007, and, through the intervention of the captive insurance movement, how the practice of medicine continued, prospered, and improved.

For it was, beginning in 2002, that hospital-sponsored and owned captives expanded their capacity to take more net risk to their balance sheets in order to support the need for professional liability insurance coverage in what was then a still-expanding marketplace. These captives expanded to include underwriting platforms assisting voluntary community medical staff members whom the St. Paul had abandoned and the rest of the commercial market was trying its best to walk away from.

I remember these days well, and I remember the number of captives this firm formed or expanded during those years, and I saw firsthand the direct social benefit that captives can have on a community…particularly when those captives are owned ultimately by 501(c)(3) organizations whose assets must be carefully preserved and utilized as part of a sustainable tax-exempt mission.

Across America in more than twenty of the key states hardest hit by the St. Paul’s departure, babies continued to be born, and their mothers continued to receive the kind of prenatal and postpartum care every woman deserves in our kind of democracy; and it happened because captive insurance companies sustained the obstetrical business in a way that allowed the highest quality of care to rise to the surface and, in consequence, for needed improvements in obstetrical care to be put in place for the benefit of all. It was captives that did this. Make no mistake. The data and evidence are quite clear that improvements in obstetrical care and in its very standards happened as a direct result of engaged hospital risk management staff who had to get into the thick of it and underwrite OBs in the community when they had no choice in 2002 and subsequent.

Many of the kids who were born as a result are now in or entering their teenage years…the social benefit of captives established again for all to see.

Fast forward to 2015, and specifically to the state of Connecticut. Imagine that you wake up one day, and you walk downstairs to your basement and find cracks in your basement foundation…and I’m not talking about the kinds of cracks that occur vertically as a result of subsidence and other factors…I’m talking about cracks that present horizontally. Cracks that look like the map of a populated urban area. Or where the cracks are so big that you can put your fingers through them into the daylight.

One by one, as these Connecticut homeowners were confronted with foundations that were rapidly deteriorating…literally crumbling into dust…these homeowners filed claims with their property insurers. One by one these claims were denied. The commercial insurance market’s position was that these cracking manifestations were a product liability matter and directly related to the existence of the mineral pyrrhotite, a naturally occurring mineral, found in concrete aggregate mix.

One by one, these homeowners discovered that their homes had become, overnight, worth 50% to 60% less than their market value or even assessed value. Retirements were postponed. Kids had to figure out other ways to pay for college. 41 towns in the Northeast Corner of Connecticut quickly began to feel the economic impact of the loss of tax revenue as these homeowners appealed to town officials for property tax relief. People’s lives were destroyed.

By the summer of 2017, the pyrrhotite natural disaster had made its way into the national consciousness. By that summer, you couldn’t sell a home in the Northeast Corner of Connecticut without a pyrrhotite core test. If pyrrhotite was found in your home’s foundation, you took your house off the market or sold it at a monumental loss. It wasn’t so much the existence of the pyrrhotite itself, it was how much was in the mix and whether it was the reactive kind, which means dampness exposed its molecular weakness. If you had built your home or renovated it roughly between 1983 and 2006, you lived in or close to the 41 communities identified with this plague, and your foundation tested positive for pyrrhotite, everybody knew that your contractor got the aggregate from exactly one quarry in Willington, Connecticut.

Some say that as many as 35,000 homes are affected. At an average foundation replacement cost of about $185,000, and with the commercial market’s continuing refusal to honor these homeowner claims for pyrrhotite-affected foundations on a consistent basis, Governor Dan Malloy reached for the only solution that seemed sensible to him.

That solution was to look into Connecticut’s captive statute and create enabling legislation that would eventually become the architecture for a captive to be known as Connecticut Foundation Solutions Indemnity Company, Inc….or CFSIC.

Why a captive? Why form any kind of insurer not destined to receive any premium or issue any contract of insurance? Why form a captive to pay claims that some would argue should have found settlement solutions within the commercial marketplace? CFSIC was formed because Gov. Malloy and a number of forward-thinking legislators on both sides of the aisle became convinced that forming a captive to deal with this crisis would force claims management discipline on the process of disbursing state funds and rebuilding the economy of Connecticut’s Northeast Corner.

In essence, state government was also convinced through evidence and example that captives, in their maturity, are recognized repositories of claim expertise, claim adjustment and management talent, and claim identification resources.

In August 2018, CFSIC was licensed. By mid-December of 2018, CFSIC will launch. When the snow clears in the spring of 2019, CFSIC will start adjusting claims, lifting houses, restoring foundations, and rebuilding lives.

We spend a great deal of time at captive industry meetings speaking about and debating topics such as the tax treatment of premiums paid to captives, whether RRGs have outlived their usefulness in this endless soft market, which domiciles are the best, etc., etc. To my knowledge, we have never discussed the issue of how captives have made people’s lives better. Beginning in 1835, the story of just how that has happened has quietly unfolded with virtually no comment from the industry. The story of how people live better and contribute more fully because captives exist has never been written about.

Or perhaps…it just has.