Captive Insurance:
Is Self-Insuring Your Company Worth It?
By: Tom Brenner
The potential benefits of captive insurance—More control over insurance coverage terms and pricing while being the beneficiary of your own good loss history by retaining unused premium dollars —make it a compelling consideration for many companies. In fact, interest in captive insurance is growing and shows no sign of abating.
In 2022, 52% of all insurance premium dollars in the US went toward captives, a jump from the 23% of insurance premium domestic dollars that went toward this strategy in 2018, according to Marsh McLennan. While this figure is expected to keep rising, does the increased popularity of captive insurance mean your company should join the bandwagon?
Before we explore some of the reasons to consider captive insurance, let’s establish what it is. A captive can be defined as an insurance company that is owned and controlled by its insureds. Its primary purpose is to insure the risks of its owners while its insureds benefit from the captive insurer’s underwriting profits. Companies effectively become the owner, or partial owner, of an insurance company, to insure various exposures within their business.
A PHILOSOPHICAL CHANGE TO RISK MANAGEMENT
Considering a captive insurance structure is a philosophical change in transferring risk. Rather than thinking like a purchaser of insurance, captive owners become managers of risk in efforts to retain a profit from unused dollars allocated to pay claims. Over time, those dollars not used to pay claims plus any interest earned on those funds, can be invested back into the company, ideally to pay for risk-management strategies that will help reduce claims even further.
ARE YOU LOOKING FOR MORE CONTROL OVER YOUR INSURANCE COVERAGE?
Entrepreneurially minded business owners and managers who are looking for a change in their insurance strategy tend to give captives a close look, particularly if they feel their current rates are too high or they want more flexibility regarding what risks are covered by insurance.
Unprecedented weather events, for example, have greatly affected premiums in recent years, causing companies to consider alternative options. On average, companies that switch to captive insurance have realized 15%-30% in cost savings.
HAVE YOU BUILT A CULTURE AROUND LOSS CONTROL AND RISK MANAGEMENT?
Companies that successfully implement risk-reducing systems are good candidates for captive insurance. With a risk-management mindset, they’ve already made progress on mitigating against potential losses. For example, incentivizing drivers who practice safe habits or implementing technology like dashcams that encourage their fleet of drivers to be safe at all times.
ARE YOU ABLE TO TAKE ON MORE FINANCIAL RISK?
Captives are usually best suited for large and midsize organizations that are both financially healthy and comfortable with retaining more risk. There’s a balance between taking on more control over your risk management and reducing costs with the financial risk (and time and resources) that is involved with managing your own insurance.
ARE YOU WILLING TO TAKE A LONG-TERM VIEW?
Captives tend to be an appropriate solution when the leaders involved consider its impact over the long-term and do not view it as a quick fix to high insurance premiums. The potential upside with captives is you are swapping the dollars you would have otherwise paid to a traditional insurance carrier with what you are paying your own captive—and your company is the beneficiary when losses do not exceed the premiums paid.
Captives make sense for companies that have a good loss history as they can earn a return on retained dollars; however, this return is not guaranteed and can require patience. Companies should not expect to realize returns until at least three to five years into the captive insurance arrangement. In the meantime, they need to build up their surplus and develop a strong, financially sound insurance system.
HOW DOES CAPTIVE INSURANCE WORK?
There are two primary captive insurance models. The first type of insurance captive is a group captive. This structure involves sharing the captive insurance benefits and risks with other companies, whether from a similar industry (homogeneous) or multiple industries (heterogeneous). This structure involves different layers of retained risk by each participating company as well as the group collectively. Group captives are designed to cover general liability, workers’ compensation, and commercial exposures. The premium threshold to strongly consider this structure is $250,000 or more from these coverages.
The second captive structure is a single parent or single cell. As the name suggests, it is designed to address the risks of a single company. Unlike a group captive, all coverages can be evaluated and considered within this structure, including property, cyber liability, directors & officers, and others. Typically, this model requires the insured to retain higher limits of risk and are best suited for companies paying more than $1,000,000 in annual premium among all insurance coverages.
Keep mind that owning and managing captives require more oversight, time and resources, and can be unprofitable. For these reasons, companies should proceed carefully and undergo a thorough assessment to decide if the strategy is worth considering. A third-party viability review, which includes exposure and policy analysis, actuarial premium exhibits, and a structure outline, will help your company determine whether captive insurance is the right fit.
Setting up a captive requires a domicile review, a five-year projection of the company’s balance sheet and profit & loss statement, and then an application process that includes legal filings, and business plans for the captive. Startup expenses can vary depending on the type and structure. Premiums are based on your company’s loss history.
CONSIDERING CAPTIVES AND STARTING THE PROCESS
With so many factors involved in deciding whether to shift some of your traditional insurance coverage to a captive insurance arrangement, you may want to start by discussing the potential upsides and issues with your Hummel advisor.
We can help you think through whether your current risk management strategies are working well for your company—or if it’s time for a change.
Benefits and Risks of a Captive...
BENEFITS:
- Control Insurance Spend
- Retain Loss Fund Dollars
- Investment Returns
- Market Insulation
- Coverage for Difficult Risks
- Subsidize Losses
RISKS:
- Unprofitable if Frequency of Claims Increases
- Catastrophic Claim Resulting in Exhausted
- Self-Insured Retention
- Collateral Requirement
- Time and Resources Allocated to Oversight of the Captive
The advisors at Hummel walk you through the process of how you can create a captive insurance program for your company. Call today.
