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Blog: Making the most of captives

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An increasing number of law firms are now using captives for their insurance arrangements as firms take proactive steps to control their own destiny and secure direct benefits from their efficient operations, says Nigel Wallis

 The introduction of lower-cost captive models, which has been taking place since the early 1990s, has been opening up the captive insurance market to professional firms.

Captive ownership tends to be by the law firm itself, an entity or a group of individuals (usually closely associated with the law firm). Law firms use captives either to insure their own risks - such as professional indemnity - or to insure the risks of their clients, such as after-the-event insurance or conveyancing and probate risks.

Most law firm captives are reinsurance arrangements where the insurance policy is issued by a UK-licensed fronting insurer taking 100% of the risk and reinsuring with the law firm's captive under a structured quota-share and stop-loss arrangement.

Five-year financial forecasts illustrate the financial value of using a captive compared with traditional market insurance, and this is the starting point for every law firm captive project.

A captive set up by a law firm to insure its own risks enables the law firm to manage its aggregate excess layer more efficiently - and potentially retain some risk in the captive itself.

It also enables the firm to access the reinsurance markets and potentially buy greater levels of cover for lower premium, subject to minimum terms. Over a number of years and subject to the level of claims, such an arrangement can enable a law firm to build up captive reserves and start to reduce its overall cost of risk.

Due to the direct correlation between claims and captive profit, it is common to see law firm captive owners bringing an even sharper focus to risk management within their firm and begin to see a virtuous circle emerging.

A captive set up by a law firm to insure the risks of its clients, such as ATE insurance for commercial or personal injury cases, enables the firm to build a long-term strategic partnership with a supporting insurer. This can lead to cover being more readily available for more cases and on better terms, the objective being the development of a sustainable insurance product that satisfies the best interests of the firm's clients.

The use of a captive also enables a law firm to back its own judgment in terms of case selection and management - and ultimately to participate in any underwriting profit in the captive that flows from this.

A law firm's ability to retain its share of any underwriting profit depends on a careful analysis of the regulatory principles appertaining to the captive structure - most notably the requirements for client disclosure and the securing of client's informed consent.

Five tips for establishing a successful law firm captive are:

1. Stress test the sales pitch - captives are not suitable for every firm and there are a few snake-oil salesmen about.
2. Pick experienced advisers and service providers - those who can demonstrate a strong track record of successful captive.
3. Don't settle for second best when selecting your supporting insurer - you need an insurer who will be with you through thick and thin and only the very best have deep enough pockets to commit for the long term.
4. Don't ignore the regulatory hurdles - take advice from a specialist regulatory law firm.
5. Be crystal clear about what it is you want from the project and how insurance fits with your overall client proposition - captives are a long-term play and suitable only for law firms that are professionally run and have a strong focus on risk management and client needs.

Nigel Wallis, Partner at O'Connors LLP

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