Beyond the Markets

Looking at the universe of commercial insurance clients in Canada is similar to looking at the basic hierarchy of a food chain. The insurance hierarchy can be roughly divided into four layers. On the bottom are the small business clients. Their insurance needs are modest—usually with an annual premium spend of five figures or even less—and easily accommodated by a plentiful market. Above them are the various layers of middle market companies. Lower middle market clients are usually defined as having annual revenues anywhere between 10 and $500 million and a corresponding annual premium spend anywhere from the tens of thousands into six figures, depending on the client. Upper mid-market companies have revenues up to a $1 billion, are often at least national in scope and generally speaking, are likely spending from hundreds of thousands into the low millions for their insurance, annually. However, the traditional insurance markets can, in most cases, still easily accommodate their needs.

Then there are the clients at the top of the hierarchy: large multinational companies with complex exposures in multiple jurisdictions. Like the large predators at the top of the food chain, they eat the most. Their annual insurance costs usually run well into the millions. And like large predators, large multinational companies have unique vulnerabilities that can belie their intimidating stature. Just as small changes in an ecosystem can suddenly leave a predator without a food supply, large multinational companies often have risks so big that they can’t easily be absorbed by traditional insurance markets.

That’s where a specialist like Trevor Mapplebeck comes in. Mapplebeck is a managing director and leader of the alternative risk financing practice at Marsh Canada Ltd. in Toronto. Just as large predators need a plentiful food supply, large corporations need lots of capital. Mapplebeck’s approach to insurance is that it is just another source of capital that is required when things go wrong and should be considered as part of a company’s entire financing landscape. In that way, you could say that Mapplebeck ensures that the polar bears of Canada’s corporate world will always have something to eat. And just as there are very few large predators at the top of the food chain, there are very few people in the country who can do what Trevor Mapplebeck does.

Risk and Finance

The bulk of Mapplebeck’s insurance career has been on the risk consulting side. But the seeds of his interest in taking a holistic approach to large corporate risks were planted in his early days with AIG and in the FinPro practice at Marsh servicing the liability needs of financial institutions. Mapplebeck points out that his clients—banks, mutual fund and life insurance companies—were all well very large, well-capitalized organizations with strong balance sheets.

“You kind of scratch your head and ask, why do they buy insurance? That question led me to the thought process into better understanding the decision-making behind purchasing insurance. At the end of the day, insurance is a form of capital and therefore the key is determining where insurance provides economic value and therefore what’s the right structure for an organization.”

Mapplebeck moved from a client executive role into risk consulting (with both Marsh and Oliver Wyman), “getting beyond the hazard and operations box and into a broader spectrum of what risk really means to organizations,” he explains. Through Oliver Wyman he gained experience consulting for large companies around the world in a variety of sectors such as agriculture, mining and energy, before returning to Marsh again to ultimately lead the alternative risk financing practice.

Mapplebeck’s job marries his risk consulting knowledge with risk transfer priorities. Most of his clients today are the biggest of the big in Canada: multinational companies with operations in many countries that tend to have very large balance sheets that allow them to retain very high levels of risk in the form of self insurance or through multi-million dollar deductibles. Companies fitting this general description are usually ideal candidates for their own captive insurance company that allow them to finance major risks themselves rather than trading dollars with insurance companies in the traditional market. But the biggest part of Mapplebeck’s job is not setting up the captive but walking the CFOs and the board through the process of just how the company should be using insurance in the first place.

“How should organizations be looking at insurance as a form of capital compared to the debt and equity that they also have access to? Where does insurance provide value for them, economically and from a risk perspective? How does it free up their balance sheet? How does it allow them to ensure that they’re using their own capital for business expansion purposes and relying on insurance as that balance sheet protection,” he says. “My role is very much about helping organizations use insurance to the best effect that they can so they retain risk in line with their risk appetite. We then turn to helping them identify how to most effectively fund for the risk that they are retaining. And that can include both deductible and retained layers.”

For instance, at the highest level, a large organization may be able to easily absorb $10 million in claims costs or deductibles across all its operating units, but those individual operating units cannot. In that case, it makes sense for the organization to have its own insurance structure in the form of a captive to fund those risks internally rather than turning to the insurance market.

Mapplebeck is reluctant to say that in effect, he helps companies not buy insurance. Instead, he offers that he helps them “to only buy insurance where it makes sense for them,” and integrate those decisions within a strong enterprise risk management (ERM) framework. Only when these determinations have been made will Mapplebeck and the client go down the road of setting up a captive insurance company to self insure some of those risks.

Costs and Captives

According to Mapplebeck, the actual legal process of setting up a captive insurance company and getting regulatory approval in a domicile like Barbados can take as little as six weeks. What can (and should) take much longer is the internal analysis a company must go through to decide if and how it should use a captive. That analysis sometimes get short changed, even by very sophisticated clients. From time to time, it happens that clients will come to him just a few weeks out from a major insurance renewal and say “We need a captive” after they find out they’re about to get hit with a huge increase or that an insurer is dropping them or the class of business entirely.

“If its eight weeks before your renewal, it’s going to be incredibly hectic to try and get through the entire process. So we always talk to our clients about the options even if they think they’re not quite ready now but may be in six months or nine months, there’s no danger in actually undertaking some preliminary analysis to at least get over that internal hurdle or staging gate to determine if a captive makes sense for them. It’s not all that difficult to get through that high level analysis. I call it a pre-feasibility assessment.”

As the situation with the panicked client at renewal would indicate, the use of captives is somewhat correlated with the market cycle. A hardening market tends to lead more people to Mapplebeck’s door looking for alternatives that will reduce an organization’s premium spend and realize other balance sheet advantages at the same time.

But Mapplebeck sees two other factors as far more important in driving the use of captives. One is the growing risk management sophistication of large organizations and the corresponding willingness to shoulder more risk rather than trade dollars with insurers. The other factor that he cites is the increasing pressure on CFOs and treasurers over the last decade to contain costs and find savings wherever they can.

“It’s not just the insurance premium, because that’s the one budget number that everybody sees. Cut below the water line and the bottom part of that iceberg is very much around your retained losses, your collateral costs, your risk management advisor and internal costs, third party administration and claims management fees,” he explains. “That tends to be a starting point to say, we can save you insurance premium costs but that means by necessity, you’re going to be accepting more risk… A captive is a wonderful way to formalize those two requirements and bring it into one fulsome view that says we’re retaining more risk but optimizing our total cost of risk.”

Captive insurers are traditionally used for things like financing the retained layers of traditional insured risks like property, general liability or US workers compensation liability. A second area where they’re used is for particular risks where traditional insurance markets either can’t provide a broad enough scope of coverage a company is looking for based on its risk profile, or where the cost of insurance for that risk in the traditional market is simply too high. He lists environmental impairment liability and business interruption exposures as examples of areas that can create volatility on quarterly statements and where a captive can be useful for reducing some that volatility.

Mapplebeck, however, is at the leading edge of delivering alternative risk financing solutions by helping clients find even more applications for captives, some of which fall outside the scope of traditional insurance altogether.

Mark Johnstone, director of global insurance for Barrick Gold Corporation, explains how Mapplebeck expanded the scope of Barrick’s captive—Aurm, domiciled in Barbados—to include risks that would seem difficult to grapple with in any conventional way. Up until a year ago, Barrick was using its captive almost exclusively to cover its primary property risks, which include 27 operating mines around the world. “We were quite conservative in how we had traditionally used our captive before this year,” says Johnstone. “Trevor was instrumental in helping Barrick identify our potential exposures,” which included things like terrorism and political violence, environmental liability, pandemic and business interruption risk.

Johnstone’s description of the process sheds light not only on the expertise Mapplebeck brought to the table, but also the process of just how an insurance solution gets built from the ground up.

“That process entailed Trevor quarterbacking the efforts involved in reviewing the risk information and doing analysis, working on it with us to develop historical potential loss estimates and going out and getting either quotations where possible from the existing markets, or coordinating actuarial analysis to validate the potential premiums that would be charged. And then Trevor would … identify the preliminary estimate of the financial benefit based on those assumptions that had been developed. So working with our tax people, working with the brokers on the team that place related coverages. Working with the Oliver Wyman actuaries where he used to work. It’s a process for us that took at least a year.”

In the end, Johnstone and Barrick opted to expand the captive to insure losses related to pandemic and environmental liability. “Trevor was a trusted extension of our risk and insurance team during that project,” says Johnstone, who still speaks with Mapplebeck monthly. Mapplebeck also accompanies him on his annual meeting with the board of the captive in Barbados and occasional meetings with the Barrick C-suite. “He’s able to present very well in front of the executives. While that was basically a project we undertook, we continue to engage him on an ongoing basis as well to continue to look at other opportunities for our captive.”

Mapplebeck sees a bright future for captives in Canada as the coverage possibilities continue to expand and as smaller organizations start utilizing them as well. “I think that view of, ‘We want to control our own destiny’ is very much at play within even mid-scale organizations,” he says. “They don’t want to be at the whim of the insurance community to determine what their cost structure will be year in and year out.” After all, every organism in the food chain needs a stable ecosystem to survive, not just those at the top.

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Copyright 2013 Rogers Publishing Ltd. This article first appeared in the March 2013 edition of Canadian Insurance Top Broker magazine.

This story was originally published by Canadian Insurance Top Broker.