Investigating Captive Insurance as an Alternative – Part 1

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Is a captive insurance company the right move for your business? This article explores the transition from traditional insurance to captive insurance.

As businesses mature and grow, they often improve and achieve best practices in various aspects of ownership, management, and operations. However, when it comes to insurance and total cost of risk (TCOR) they are often stymied by alternative approaches to gain control of the “sunk cost” of their insurance premiums. Over the past decade there has been a renewed interest in captives as middle market companies seek to reduce and control their TCOR and insurance premiums. In doing so, they become aware of some of the advantages captive insurance offers or provides in customizing coverage, gaining control, and containing costs, including:

  • Customization of policies – limits, forms, and retentions.
  • Increasing risk management/claims control.
  • Reducing insurance spend.
  • Improving cash flows.
  • Stabilizing cost of risk to the operation.
  • Realizing investment returns.

Business owners are intrigued by the captive concepts, yet often they do not know how to determine if a captive would be a viable solution for their company. This whitepaper provides a simple basis for middle market companies and their brokers to assist in determining if their organization would be a captive candidate and, more importantly, if captives would be an appropriate and potentially advantageous decision for their enterprise.

When contemplating a captive, first and foremost, there must be an understanding that a captive is an insurance company organized to reduce premiums and TCOR and to provide risk finance stability. Captives are not a short-term cost or coverage decision, nor an insurance quote or purchase. Captives are an intentional long-term business strategy and correspondingly a long-term decision. When considering captive alternatives, time and trust in the professionals you engage to assist in analyzing and implementing is vital.

The following are characteristic traits and qualities of companies/organizations which would be likely candidates and which should consider in earnest a captive solution.

  1. Stable privately-held or closely-held organizations that are well established and are cash flow positive. Capital is required in captives. Further, long-term organizational success and predictability strengthen the concept.
  2. While these numbers can fluctuate by industry, typically the company has more than $20 million in gross revenue and 75 or more employees.
  3. For the potential savings within a captive to offset the capital requirements and captive overhead, a captive candidate should have significant premium spend in traditional insurance, higher deductibles, and/or have substantial existing uninsured risk. Typical traditional premium spends for captive candidates are:
    • Group captive: not less than $200,000 for casualty lines – workers compensation, general liability, and business auto combined.
    • Pure captive: at least $1 million (single parent – captive only insuring its parent and parent’s subsidiaries).
    • $500,000 in premiums for cell structure to address and insure enterprise risk, uninsured risk, traditional deductibles, etc.
  4. When considering a captive, an organization must be willing to take risk, including shared risk (risk distribution), and be able to determine and understand/define their own risk tolerance or appetite. Captive candidates should have an entrepreneurial spirit and generally consider themselves as risk takers, within reason, in lieu of being risk adverse.
  5. Companies investigating captives as a solution must be willing to experience and pay for loss. Captives are established to finance risk – which means to pay for losses that occur within a specified level or layer. Captives are insurance companies that must be able to pay their claims within that accepted layer.
  6. Captive candidates must be historically better than average in loss experience with reasonably predictable insurance risks. They are generally best-in-class business operations with proven safety and organizational track records. Captive candidates are often frustrated by having to pay traditional premiums when they historically have low losses.
  7. Proactive and above-average risk management/loss control/safety programs must be in place and emphasized. When assuming your own risk it is vital that organizations control and mitigate risk. Captives play a vital role in enhancing the programs by funding them directly.

Determining If/When a Captive is a Right Fit

In conclusion, it is important to recognize captives are not a fit for every company, and there is not a perfect scenario as to when a company is ready and should create or enter a captive. Understanding of captives, analysis of feasibility, and timing are all vital. An organization with the traits outlined in this article would be wise to partner with their brokers or experienced captive consultants to understand and analyze if, how, and when the long-term solution to risk finance and stability for their organization is answered by captive insurance.

Holly Wagner is an insurance advisor with over 30 years of experience encompassing captives/alternative risk, large commercial, and risk management consulting. She has extensive experience in energy, construction, manufacturing, global accounts, and health care. Holly dedicates her efforts to customizing coverage to each individual client's needs and risk tolerances.