Opinion: Trends in how construction firms transfer risk

Hunter Johnson

There are mixed projections in the construction space for 2025 – from a possible recession to continued strong backlogs and no slowdown in sight. These views reflect varying levels of optimism across market segments, geography, and still present challenges like rising labor costs, rising legal and insurance costs, skilled worker shortages (although easing), interest rate uncertainty and limited financing.

One commonality amongst respondents, however, would be the likely continued challenges that owners, chief financial officers and risk managers will face with regards to their overall insurance program in this hard insurance market environment that is now entering its eighth consecutive year. Optimism from the insurance industry perspective is improving entering 2025 with sufficient capacity, more appropriate risk attachment points and a diversified portfolio of risk available, but analysts still project moderate rate increases for most accounts, especially across auto liability, excess liability and general liability lines of business, according to a marketplace outlook from WTW. This, of course, does not bring much relief to organizations that have seen consistently higher-than-inflation rate increases over the past seven renewal cycles that reached a peak and 20-year high average rate change of 11.7% in first quarter 2020, according to a market report from the Council of Insurance Agents & Brokers.

To combat these challenging market conditions, well performing and financially stable construction firms have increasingly sought more creative ways from the insurance industry to transfer risk and purchase insurance for their organizations. Alternative methods of risk transfer like captive insurance, integrated aggregates, retrospective rating plans and self-insurance have increased in popularity in recent years with national brokers such as Alliant, Marsh and Willis reporting as many as 15% more of their clients entering these types of arrangements each year since 2018.

Alternative risk transfer can offer insureds many benefits including lower premiums, more stable renewal expectations, enhanced control and more tailored coverage with broader terms than are available in the commercial marketplace, and the ability to monetize the organization’s positive claims performance. Captive insurance, and more specifically group captive insurance, has been the most popular such mechanism for small- and middle-market organizations to consider with some captive programs offering premiums 10%-20% lower than traditional insurance initially, according to reporting from the American Bar Association, and as much as 50% over time.

A captive, in its simplest form, is an insurance company that is wholly owned and controlled by its insureds. And although the primary function of the captive is to insure various lines of casualty insurance for its owners, it also serves as a financial vehicle allowing members to earn income on invested premium and dividends on return premiums not used to fund claims activity. As with traditional insurance companies, a group captive is recognized as an admitted insurance carrier and regulated by state law. Policies are fronted (or issued) and administered by a licensed insurance company that offers services such as underwriting, loss adjusting and regulatory support; with the captive underwriting and drafting the insurance policies and a third-party claim administrator that handles claims for the members. Therefore, the member/owner obtains all the same services that they expect from a traditional insurance carrier and receives a policy that responds to claims. The difference is in how the program is structured, with rates that are based on an insured’s actual loss experience rather than market rates, and shared program costs including reinsurance that are based on the pooled experience of all the other members.

When evaluating a pooled risk vehicle, like group captive, firms first undergo a feasibility study of its past claims to understand its current standing and likely future performance. Firms that have positive loss history (generally, a loss ratio of less than 35%) and annual premiums in excess of $250,000 may be a good candidate. Second is to understand the risk profiles across the pool of members – including their risk control practices, shared commitment to safety and shared approach to investment returns to determine which group is the right fit. In the construction industry, construction defect and workers compensation risks are so specific to each trade, there exist captives that are made up solely of certain trades (homogenous), as well as captives that include many types of trades and members operating in other industries (heterogenous) that give members more comfortability with either a large concentration of similar risk – or risk distribution across the heterogenous group of industries.

For firms that determine pooled risk options are not the ideal for them, there are other individual agreements that can be made between insureds and their insurance carrier that creatively structure risk retention and premium reimbursement incentives for positive claims performance.

Hunter Johnson is vice president of Alliant Insurance Services Inc., specializing in workers’ compensation, alternative risk financing and complex risk placement. He can be reached at hunter.johnson@alliant.com.