Risk Management

How Captives Can Cut Supply-Chain, Cyber Insurance Costs

With premiums rising for cyber insurance and supply-chain coverage, CFOs and risk managers can curb the expense by self-insuring.
Jeffrey C. JoyJune 24, 2014
How Captives Can Cut Supply-Chain, Cyber Insurance Costs

CFOs of corporations that have already set up captive insurance companies or are thinking about setting one up should ponder the benefits of self-insuring cyber perils and supply-chain business-interruption (BI) risks via a captive to supplement   commercial insurance coverage.

Indeed, the financial risks to companies from cyber attacks are increasing at an alarming rate, according to recent research by McKinsey & Co.  Similarly, many smaller companies may not have adequate contingent business interruption insurance coverage.

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Adding comprehensive or supplemental cyber risk and BI coverage through a captive should be considered an important contingent component to any company’s strategic risk management plan. These risks are real for most companies, and the potential damages to a company’s revenues and profits can be significant.

A cost-effective strategy can blend organizational risk management with an insurance program that includes captive coverages.  Indeed, captive-insurance policies can be specifically crafted to cover a company’s highly individualized risk.  That’s an advantage in the case of cyber and business-interruption losses, which manifest themselves differently in every company.  For example, one company’s costs relative to a data breach might include exorbitant notification expenses under state and federal law and high monitoring costs. Another company might absorb significant expense in recovering stolen or compromised data, but less on the notification and monitoring side.

Opinion_Bug7At the same time, the commercial insurance market isn’t entirely suited to writing  risk in a highly specific, individually tailored fashion. Commercial insurers prefer to broadly standardize coverage, tending to underwrite in a way in which one size can fit all of a diverse insured population.  That’s been particularly true in the case of commercial general liability (CGL) coverage, a broad type of insurance written on a standardized form, and it’s starting to be true of cyber coverage as well. Indeed, commercial cyber-insurance policies are also starting to look alike standardized.

Moreover, supply-chain and cyber insurance policies routinely exclude certain coverage. Commercial supply-chain insurance, for instance, may be limited to coverage of a company’s loss of income and ongoing expenses as a result of physical damage to an insured’s plant, building or other facility. Further, a rider may not be available to extend such coverage to losses stemming from damage to the premises of a supplier, or the rider may cost too much. In such cases, a supplemental policy written via a captive to cover these additional risks can be an effective risk management solution.

Similarly, if supply-chain insurance has geographic limits that exclude the part of the world in which a company’s suppliers are based, a supplemental policy written by a captive can cover such risks.

Cost-Cutting Steps

To be sure, commercial carriers are offering cyber-insurance policies that cover first-party and third-party claims.  First- party coverage typically includes losses to an insured’s computer data or other harm to the company’s business resulting from a cyber attack or data breach.  Third-party coverage, which insures against claims brought by customers or clients that suffered losses as a result of the cyber attack on the insured company, typically pays for the costs of lawsuits.

But premiums for both supply-chain-interruption insurance and cyber-risk coverage are increasing annually. With that in mind, CFOs and risk managers at smaller companies could help their employers achieve significant premium savings by taking the following steps:

1. Increase the company’s deductible on commercial coverage for those risks — boosting them, for example, from $50,000 to $250,000 on a policy with an overall coverage limit of $2 million.

2. Self-insure the $250,000 deductible, as well as the excess risk from $2 million to $5 million, through a captive.

3.  Alternatively, all or a portion of the coverage over $2 million could be reinsured with a commercial carrier to reduce the potential loss to the captive’s reserve account.

In the current environment, combining commercial cyber-risk and supply-chain-BI insurance with coverage written through a captive can provide businesses with more comprehensive and cost-effective coverage of these risks.

Jeffrey C. Joy is a tax attorney and Shareholder in the Orange County office of international law firm Greenberg Traurig LLP.