Companies are being challenged by the confluence of COVID-19 and a hardening Property & Casualty insurance market. For many businesses, this has resulted in a deterioration of financial results at a time when risks are increasing. One potential option for managing risk in these uncertain times is a captive insurance arrangement.

Broadly defined, a captive is an alternative risk financing structure used by many companies to efficiently self-insure risk. It allows a company to self-fund for traditional and emerging risks. This can include those that are unavailable or unaffordable in the commercial market (i.e., pandemic, supply-chain risks) many companies have recently experienced. Further, in a hardening market, many organizations will seek captive options to assist them in reducing overall insurance costs. While a captive can be a valuable alternative risk strategy, not all businesses qualify for captive formation. 

Generally speaking, companies that have formalized risk management programs, reasonably predictable insurance risk and adequate premium and loss experiences in comparison within their industry may qualify. Several factors should be considered before taking on a captive insurance plan.

Your organization may qualify for a captive if:

1. Does your company have a long-term strategy regarding risk management and risk financing?

A captive is a strategic, long-term approach to risk financing for companies who have a positive loss history and are proactive with regard to safety and loss prevention. It is not a way to respond to short-term market fluctuations but rather should be based on a broad risk-retention strategy.

2. Does your company retain significant risk via self-insured retentions or large deductibles?

Similar to self-insured retention (SIR) or deductible programs, captives are a form of self-insurance. If your company already assumes some risk through one of these mechanisms, moving into a captive can provide additional benefits, including lower administrative expenses and the accelerated recognition of claims expense. These permit the development of equity within the captive over time. However, captives may require additional collateral and may not provide the same cash flow as these other structures. A detailed feasibility study will highlight the differences.

3. Does your company have significant exposure to loss?

Common risks associated with captive development include workers’ compensation, automobile liability and general liability. Other risks, such as professional liability and management liability, are also easily funded into captives. However, the key to a successful captive is actual loss experience. If your company has significant exposure to these risks and outperforms your peers relative to losses, a captive may be worth exploring. 

4. Does your company have predictable insurance losses?

Companies that boast a strong culture of safety will outperform peers over time as their claims experience will be relatively consistent year over year. If your company fits this profile, a captive can provide the coverage required, while returning the underwriting profit to your company rather than a commercial insurer. As there is risk involved, a captive ownership is a long-term strategy.

5. Does your company pay in excess of $250,000* in annual premium?

There are many metrics used to determine captive feasibility. One is the total premium paid for the lines of coverage to be placed into the captive. Generally speaking, companies that pay higher premium for coverage like workers’ compensation, auto liability, etc. will see greater long-term advantages. Captive structures like micro-captives and group captives can be developed for smaller companies as well.

6. Is your company a for-profit entity?

At their core, captives provide their owners with a more efficient way to finance risk. They may also provide secondary, or collateral benefits, including tax advantages. While captives are therefore commonly formed by for-profit companies, nonprofit organizations may also benefit from captive formation. For example, many nonprofit hospitals and health care systems use captives to fund professional liability and medical malpractice risk. Regardless of your organization’s profit status, a captive can provide efficiency and allow the owner to benefit from good loss experience.

7. Are your company owners/leaders willing to commit additional time and resources to captive administration?

Some of the administrative details involved with running a captive insurance program include keeping books and records up-to-date, preparing internal financial statements and reports, monitoring the marketplace, ensuring regulatory compliance, claims management and more. It requires time and effort to administer, so leadership must be willing to make that investment.

In addition to considering these questions to help determine if you qualify, you should also evaluate if your organization has the right characteristics to be successful.

Foundations of a Successful Captive

• Focuses on risk management  & cost efficient risk financing as the primarybasis.

• Complies with all regulations (e.g.,IRS, insurance regulators)

• Operates as a genuine insurancecompany (i.e., it will pay claims).

• Provides coverage for real risk.

• Utilize a lasting approach to riskmanagement & transfer strategies. Refrain from a tactical response tomarket conditions or potential tax benefits.

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Captives are a long-term strategy for funding risks that might impact your business or otherwise have a negative effect on your balance sheet. As a self-insurance option, captives are a risk-reward structure. So, companies that effectively manage risk can enjoy many benefits, including having premiums returned to their bottom line. Connect with a member of our team regarding questions about alternative funding options to manage your risk