Purchasing insurance continues to be difficult and expensive for construction firms. While the risks contractors face every day in their businesses may not have changed much in the past three years, the insurance industry certainly has. Many carriers have pulled out of the construction trades altogether, and there continues to be a consolidation of the major players left in the marketplace. Contractors are attempting to control a very large business expense with fewer and fewer options and more and more uncertainty.

Captive insurance has become a solution for many contractors. A captive insurance company finances the risk of its owners or participants. Kate Westover, a captive insurance expert and author of the insurance industry's definitive book, Captives and the Management of Risk, helps contractors and other customers create and manage captive insurance companies.

"Captive insurance suits the construction industry well because those in that industry manage risk every day," said Westover. "In a captive, a group of contractors comes together to form their own insurance company, where they can control their own premiums and coverage amounts and manage their own risk for workers' compensation, general liability and automotive coverage."

While captive insurance is designed to save money on insurance premiums over time, it is the control that captive insurance offers a contractor that is usually the most appealing. As owners in a captive, contractors have control over costs, control over the services being provided from claims management to reinsurance, control over who becomes a shareholder in the captive, control over how much risk and what type of risk the group wants to assume, and ultimately control over the captive profits.

Contractors who are financially sound, manage and run good solid companies, and maintain a good safety record can benefit and profit from insurance costs through a captive insurance company.

"There are only so many variables for holding down costs and being more competitive. Insurance is one of those variables, and we decided to take control of it through captive insurance," said Pete Castellarian, chief financial officer of M & O Insulation Company, Chicago, the largest insulation contractor in the Midwest and one of the top five nationwide. M & O is part of a captive owned by 12 Illinois construction firms. "All the firms have a comparable emphasis on safety, so captive insurance is really a win-win for everyone. It drives down our costs and makes us more competitive."

Insurance typically works on a 60/40 ratio. For every dollar a company spends on insurance, approximately 60 cents is earmarked toward potential losses, while 40 cents goes to fixed costs, which would consist of the insurance company's overhead and operational costs. In traditional insurance arrangements, a piece of business that has a 60-percent loss ratio or less can be profitable for the insurance carrier. In a captive insurance company, the contractors benefit because they take control of their insurance dollar. While any part of the 60 percent for potential losses goes unused, that amount will be used to accrue investment income and ultimately will be attributed back to the captive owner as underwriting profit and investment income.

Progressive Contractors, Incorporated, a Minnesota-based highway contractor, is a company that is benefiting from the investment returns captive insurance offers. Progressive is partnered with 12 other contractors in a construction-centered captive insurance company.

"We now understand that it is not what we pay up front that matters, it is the amount of losses we pay out that determines our success. A captive solution gives us a way to stabilize the cost of insurance and to see financial benefits through underwriting savings and investment income, "said Mike McGray, president of Progressive Contractors.

Captives vary in size, anywhere from a single contractor to 50 or more contractors working together. A captive should be small enough to be manageable, but large enough to gain economies of scale. The amount of the initial capital investment required from each captive owner is determined by the captive structure and the requirements of the chosen captive domicile.

A captive consultant, such as Innovative Captive Strategies, Inc., assists construction firms and insurance brokers in performing feasibility studies for potential captive ownership. This includes analyzing recent loss history, safety controls, payroll and revenue, and overall goals and objectives, thereby determining risk management needs.

"To qualify for our captive, partnering companies had to show solid financial performance and good loss histories," said Mark Knight, vice president of Foothills Contracting, Inc., a third-generation, heavy highway construction firm that builds highways and byways throughout the upper Midwest. Knight stresses the additional benefit that comes from running a captive company: a more safety-conscious company.

"With traditional insurance, workers' compensation was one of our largest and most expensive lines of insurance. Although it's a regulated cost, the enhanced loss control program we now have in place because of our captive company enables us to control that cost, too," said Knight.

The opportunity for networking with other owners on best practices is another advantage of being in a captive.

"The partner companies in our captive come from diverse industries, but we have important things in common," said Stan Lanford Jr., chairman of the board of Lanford Brothers Co., Inc., a general contractor that works with state transportation departments in Virginia, North Carolina and South Carolina. "We are all second- or third-generation family-owned companies with strong balance sheets and corporate cultures that emphasize safety from the top down. We learn from each other."

In today's economy, contractors have little control over expenses, such as insurance, labor and fuel costs. Captive insurance effectively gives the control back to the business owners by allowing them to "own" their insurance as opposed to "renting" it. They will be in a position to control and stabilize premium costs by controlling their losses and directly benefiting financially from the profitability of their captive insurance company.

Construction company owners who want to learn more about captive insurance should contact Innovative Captive Strategies, Inc. (ICS) or ask their insurance broker. ICS works with brokers nationwide to determine if captive insurance makes sense for their construction-industry clients.