Although captive insurance has been around for over a century, common myths continue to dominate this self-insurance solution. Captives are used by companies of all sizes and configurations and across industries, offering significant benefits over many traditional insurance models. Still, persistent myths have served to cause business owners to shy away from captives. These myths ultimately hamper growth in the sector. In this guide, we will explore several common myths about captive insurance, helping to dispel them and to give business owners the information they need to make smart insurance decisions.
Created at the beginning of the 20th century, captive insurance differs from the commercial insurance market in that captives are a wholly-owned entity for the sole purpose of providing insurance coverage to its parent business or group of businesses. Previously reserved only for the largest of corporations, captives have become a cost-effective and flexible insurance solution for many businesses, regardless of size or risk exposures. According to the National Association of Insurance Commissioners (NAIC), there are over 7000 captives doing business around the globe.
Many of the most common myths associated with captive insurance are centered on their role and their purpose in the business world. In a panel discussion at the Bermuda Captive Conference in 2018, industry experts spoke about several myths, including:
In their earliest iterations, captive insurance entities were created by large corporations with the capital and expertise needed to establish the captive. Large companies still rely on captives, typically in a single-parent or group captive format, but smaller companies can now take advantage of the lower barriers to entry represented by protected cell captives, risk retention groups, or traditional group captives. These types of captives either pool risks and finances or segregate them under the umbrella of a sponsoring entity that manages the captive. Smaller businesses gain the flexibility and cost savings associated with captive insurance coverage without the expenses or headaches of establishing a single-parent entity.
Certain tax advantages are a hallmark of captive entities. The companies owning captives benefit from the ability to deduct taxes on premiums paid, potentially saving thousands or even millions of dollars in taxes each year. Unfortunately, certain companies have tried to take advantage of the tax laws, establishing captives solely as a shelter and not as a legitimate insurance solution. The Internal Revenue Service (IRS) and state level insurance regulators place strict requirements on captives to prevent abuse; the IRS has targeted numerous captives for audits as a result.
Some industry sectors, such as those in manufacturing, professional services like law or finance, healthcare, and construction are considered high risk. As such, these businesses may have difficulties in obtaining or affording traditional insurance coverage. Captive insurance, then, forms a viable alternative. The myth that only high-risk companies benefit from captives persists. It is not only high-risk industries that benefit from captives, however; any company that wants to take charge of insurance coverage and expenses can use captives as a solution. In some cases, low-risk but unusual businesses may not be able to obtain appropriate property and casualty coverage in the commercial market. In other cases, businesses with low risks simply want to save money and gain tax advantages through establishing or participating in a captive.
One final myth surrounding captives discussed at the Bermuda conference was centered on the belief that captive insurance entities “trap” cash. Billions of dollars in capital and surpluses exist in the captives market, which has caused unknowing company financial officers to become fearful of the captive model. One group of captives managed by a single company has an estimated $106 billion in capital, but over $76 billion of this money is loaned back to parent companies. In other words, capital and surpluses are available for use as needed, whether or not losses are experienced by the parent company.
Captive insurance has become a sophisticated and comprehensive solution for many business owners desiring the ability to self-insure their own risks. While captives aren’t for every business entity, they represent a viable and secure insurance option and will continue to grow as more is learned about the benefits captives have for the business world.
Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.