Every business addresses risk finance and risk management in unique and individual ways. For most, they are addressed through traditional insurance: you pay a premium to an insurance company, and that company pays your claims. If you do not have claims, that company keeps the premium as underwriting profit. In traditional insurance the only one that benefits if you have a good claims history is the traditional insurer. It’s simple and effective – but it’s not the only available solution to risk finance and insurance solutions. A growing number of middle market companies are seeking innovative solutions beyond the traditional insurance market. Captive insurance is an alternative they are finding.
Captive insurance is an alternative approach to manage your premium spend or risk finance. This white paper includes further explanation into captives, their benefits, and their risks to assist you in determining whether a captive could be right for your firm or enterprise.
What Is Captive Insurance?
A captive is an insurance company owned and controlled by the insureds. Its primary purpose is to insure the risks of its owners, and its insureds/owners benefit from the captive retaining underwriting profits. Captive insurance is referred to as a type of self-insurance, but it resembles a traditional insurance in that it is an insurance company which issues policies, pays claims, and is regulated in the state or domicile in which it is formed.
Reasons Captive Insurance is Appealing
REDUCING INSURANCE COSTS. With a captive, there is a more direct savings opportunity. A captive differs from traditional insurance in that when you own your insurance company you benefit from monitoring and decreasing expenses and overhead, you realize the investment income and reserves, and you retain the underwriting profits.
Additionally, in a captive you are underwritten based on your specific loss history, operation, and safety practices, so there is opportunity for lower premiums. In comparison, traditional insurance underwrites your company lumping you in with a pool of risks (good and bad), and premiums are based on the loss results of that pool of risks and the overall profitability of the insurer.
Further, in traditional insurance $0.50 to 0.60 of every premium dollar goes to overhead. The balance is used to pay losses. If there are no losses, the traditional insurers keep that money (underwriting profits). A captive generally has less overhead (no brick and mortar buildings, no employees, and no Super Bowl ads). Generally, a captive has $0.38 to 0.45 per dollar of overhead – if there are no losses the captive owners keep the underwriting profit.
DATA. Being the insurance company, you have transparency and control the claims data. Knowledge and data are powerful. Captives have all the knowledge you need about claims types and frequency, which helps in claims cost reduction and mitigation.
CONTROLLING YOUR RISKS. Once you have claims data, you can identify risks that are the most impactful cost drivers and allocate resources to manage these risks by intentionally dedicating resources to loss control/risk management. Captives are intentional and active with risks, loss control, and claims management – when you can either lose the dollars to pay claims or keep the dollars as underwriting profit, you’re significantly more diligent.
COVERAGE CUSTOMIZATION AND FLEXIBILITY. With captive insurance you can customize your coverage to meet your unique needs, addressing exposures that are expensive, hard to insure, or excluded by traditional insurers.
What Policy Lines Can Captives Be Used For?
The captive model can be used to meet a wide variety of insurance and risk finance needs, including:
- • Workers compensation
- • General liability
- • Auto liability and physical damage
- • Commercial property
- • Enterprise risks
What Are the Risks?
When you join or form a captive, you gain more control, but you also accept more risk. Risk tolerance is necessary. You will always know and accept the amount of your capital required and at risk. Strategic and defined stop loss reinsurance placement is necessary to address the times you have higher claims than projected.
Captive insurance is a self-based product, so claims handling must be carried out reliably by your own dedicated efforts. This requires resources and expertise, usually from a third-party administrator; therefore, the captive must diligently oversee and manage the adequacy and service of these third-party administrators. Administrative policies and procedures must be defined and executed to ensure that coverage is determined and that appropriate claim payments are made consistently.
Insurance companies, including captives are regulated. Captives must be formed in compliance with domicile (state or off-shore) laws and must continue to be compliant with the regulatory authority and statutes. While generally handled by the captive manager and consultant, a captive must assure it is meeting these requirements.
Captive owners must dedicate time and resources. You have control and ownership of an insurance company and stand to earn benefits from its overall profitability, therefore diligent stewardship through participation is necessary. At minimum, board and committee meetings are required of the captive owners generally one to two days, once or twice per year. If you are going to own or enter a captive, you will have high standards and expectations
Prior to forming or entering a captive, it is important to be aware of and understand when accepting the ongoing risks and obligations.
A captive insurance program may or may not be viable for your enterprise. However, if you closely and carefully assess the pros and cons and you are capable and willing to use capital and time, you should acquire the necessary expertise to assist in analyzing and transitioning to a captive alternative with an intent to decrease insurance costs, implement better controls, and customize coverage specific to your operations.