Captive insurance often provides the coverage a business needs when a conventional market can’t provide coverage, when it costs too much, or when prices fluctuate. However, this alternative approach to insurance offers many benefits, beyond what your company might find in the regulated commercial insurance marketplace.
What Is Captive Insurance?
Instead of buying insurance through the conventional market, captive insurers pool multiple companies to form a single insurance company. Policyholders own and control a “pure” and manage its resources.
Each company in the group captive contributes their own capital, but they also control the resources, decide on investments, and share profits and losses. Additionally, each member company also enjoys the benefits of any money left in the fund when premiums exceed losses, and any interest earned on investments.
Each member company can analyze any investment and choose the best in class, instead of what the traditional market decides.
Since each member company is also an owner in the insurance company, they are also invested in improved safety, fewer claims, and tailored policies that address their needs. Member companies can align themselves with others with good safety records too, instead of subsidizing less diligent companies.
Company members have every reason to do their best, since they directly enjoy the benefits. They pool their buying power and learn how to improve coverage, manage premiums, and improve the claims experience.
When they control losses, manage claims properly, and encourage a strong safety culture, they also improve their returns.
Address Insurance Limitations
Many companies choose captive insurance, because they can’t obtain coverage, it’s too expensive, or prices fluctuate too much. When the traditional marketplace can’t offer what you need, captive insurance can offer tailored coverage for an average premium reduction of 20 percent.
Member companies also have direct access to wholesale reinsurance markets, increased coverage and capacity, funding flexibility, and underwriting choices and leverage. Plus, as the captive grows it also has greater risk capacity.
Lower Expenses – Improve Cash Flow
When you use captive insurance, you’re not paying the markup for an underwriter, so member companies can invest the money instead. They can also add this money to any interest earned from premiums held in investments, which averages around 25 percent.
Additionally, traditional insurers typically reserve at least 60 percent of premiums for loss payments. Captive insurance has lower expenses, so it is only necessary to set aside between 5 and 15 percent.
Potential Tax Advantages
Captive insurance may offer tax advantages through interest earned on investments and premiums claimed as an expense by the insured.
If the captive is an incorporated insurance company, you may be able to claim a “reasonable and fair” loss reserve for unpaid actual losses incurred. Your business may also reduce state premium taxes you’d normally pay through a commercial insurance program.
However, you’ll need to discuss tax implications with your accountant, as laws vary depending on your resident state and member companies. It shouldn’t be your primary motivator either. Your business exposures and risk management issues are of greatest concern.
An alternative to a captive insurance company entirely owned by its’ members is an agency captive insurer. Members may pay an access fee instead of investing capital, but they don’t own the captive.
An agency captive has an advantage since it can maintain legally separate underwriting accounts, while a pure captive shares risk with the other captive insureds. Member companies still control their risk management decisions, but the insurance agency insures the risks of the client.
An agency captive is often a good choice for small companies to build surplus so they can start a pure captive insurance company later.
If you appreciate the benefits captive insurance offers, you should conduct a feasibility study and contact a captive manager. They have the skills and knowledge you need and can walk you through the process.