The captive alternative: a basic fiduciary obligation: once considered the exclusive domain of larger companies, capitves are now emerging as a cost-sensible long-term solution for smaller and mid-sized enterprises, too.

• Author: Whitehead, William G.

Keeping major financial risks adequately funded is one of a financial executive's basic fiduciary obligations, yet many are finding their ability to fulfill this obligation seriously handicapped. As exposures in certain areas have skyrocketed, some of the most vital lines of insurance--from professional liability insurance to workers compensation coverage--have become scarcer or extremely expensive in the traditional property-casualty insurance market.

Annual premiums in some insurance lines have soared as much as 200 percent over the past few years. Many insurers will no longer underwrite certain lines--or have become financially insolvent, which makes an effective transfer of some risks in the conventional way essentially impossible.

This situation not only presents a major professional challenge--it places senior finance executives and their boardroom colleagues squarely in the path of significant personal liability. The failure to properly insure or self-fund critical financial exposures could damage an organization's balance sheet and quickly mire management in costly securities litigation.

Worse yet, this predicament could arise without the financial safety net expected from a directors & officers (D&O) liability insurance policy, since D&O insurance contracts expressly exclude claims arising from failure to maintain proper levels of insurance. That means that in the event of litigation, an individual's personal assets could be on the line.

To avoid this scenario, all financial managers must perform extensive due diligence in assessing and funding significant financial risks. With the scarcity and expense of some traditional risk transfer insurance hampering many companies' ability to address certain exposures, this due diligence process is leading many financial managers to examine insurance alternatives. As a result, the alternative risk transfer (ART) market is expected to encompass nearly half of the U.S. commercial insurance market by yearend 2003.

Captives are the most popular of the alternative options available. Once considered the exclusive domain of larger companies, captives are now emerging as a cost-sensible long-term solution for smaller and mid-sized enterprises, too.

What exactly is a captive? What can it do for individuals and an organization's financial health?

Many Answers

If you ask 20 savvy financial executives "what is a captive?" you can expect 20 different answers. All would agree that a captive is an insurance...