Adding to the Mix: Self-insurance is now a multibillion-dollar industry that accounts for as much as one-third of the commercial market. (Property/Casualty).

In recent years, the insurance industry has shaken off an image of resistance to change and has emerged as a force in meeting the financial challenges of an ever-changing economic environment. The evolving theory and practice of insurance has given us new strategies for protecting and enhancing assets and contributing to economic growth. The result is a convergence of insurance and financial markets and a new class of exotic financial options, complex structured products and alternative risk-transfer solutions.

These sophisticated theories and exotic structures can add value and flexibility to a corporation's financial plan, but they are not meant to replace the fundamental principles that support our core function--the protection of assets. New options to maximize resources won't make much difference if we are in danger of losing those resources.

At the most fundamental level, two insurance strategies have been around for decades: insurance purchased from a third party and self-insurance. Over the years, however, variations have evolved to meet changing times and trends. Among the most significant are the rapid growth of self-insurance and a proliferation of self-insurance options. Once a novelty, self-insurance is now a $100 billion to $130 billion industry that accounts for as much as one-third of the commercial market. Today, there are few large corporations that do not employ a mix of conventional and self-insurance products.

Perhaps the best-known financial strategy is a wholly owned or captive insurance company. This very flexible vehicle can assist with managing retentions, while offering the corporation streamlined access to the reinsurance market and currency repatriation. In the United States, regulatory bodies viewed captive structures as tax-avoidance schemes, rather than effective financial-management tools, and they imposed regulatory hurdles restricting the financial benefits. But now there appears to be a begrudging acceptance of captives as legitimate financial tools.

For companies with the inclination but not the size, rent-a-captive structures are available. While an efficient use of capital, the need to "share" risk often makes this a difficult structure to protect the financial assets of participants. Captive-friendly jurisdictions have been supporting protected-cell companies. These maintain the cost effectiveness of an established captive with the financial efficiency of rented capital, while preserving the financial independence of the cell owner.

Finite insurance--capitalizing on favorable accounting regulations of foreign jurisdictions--also can be structured for retentions and deductibles. Conventionally, finite solutions are better known for exposures such as environmental contamination and loss-portfolio transfers. A variation--exposure buyback--developed in partnership with an offshore insurer, can provide a streamlined, captive-like entity preserving the benefits of both an insurance premium and positive loss experience.

One dramatic development is the Columbia Energy ruling, which supports funding of self-insured employee benefits in a wholly owned domestic captive. While not a new concept, there are unique aspects to Columbia Energy's exception. Most important, this appears to be the first exemption to PTE 79-41, the ruling that allows for the filing of an exception to the Employee Retirement Income Security Act of 1974 should a company wish to fund employee benefits through a captive. Until the Columbia Energy ruling, ERISA would grant an exception only if the captive had 50% or more in unrelated, third-party business.

Interestingly, the Department of Labor does not consider the funding of benefit programs to constitute third-party or unrelated premium, but the IRS does. Historically, one of the most compelling cases for premium deductibility for captive insurance cessions has been the amount of third-party, or unrelated, premium. While some companies could fund a natural extension of their business, such as warranty programs, many are reluctant to provide innocent capacity.

The financial community is watching the Columbia Energy development with great interest. The ramifications are important for managing self-insured risk. This should present a compelling case for premium deductibility and may be the catalyst to break down bureaucratic barriers between benefit and casualty management. The result would be the growth of integrated disability management. Should the Columbia Energy ruling become an acceptable template, there will be a proliferation of self-funded employee-benefit programs in the United States.

A related benefit will be the rejuvenation of onshore captive formations in the United States. This should serve to maintain the growth of Vermont and Hawaii and provide the impetus for significant growth in promising new jurisdictions, such as South Carolina.

Leslie Boughner is senior vice president at Alternative Financial Products, CNA, Chicago.

Products, CNA, Chicago.