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Weighing the Pros and Cons of Captives

For many business owners, traditional insurance protections are prohibitively expensive. In some cases, insurers are reluctant to underwrite policies for unusual or high-risk profiles, making traditional insurance all but impossible to obtain. Captive insurance solutions stand out as a viable alternative to the traditional insurance market. This insurance model can reduce costs, add flexibility, and provide the necessary property and liability protections demanded by businesses. Still, captive insurance solutions are not for every business. For business owners, gaining an understanding of the pros and cons of captives can help them make more informed choices about the insurance protections they need to protect their assets.

Captive Insurance Solutions: An Overview

At its most basic, a captive insurance company is one owned and controlled by its insureds. In other words, nearly any company can form its own captive, giving rise to the term “self insurance”. The primary purpose of a captive is to insure the risks of its owners or members; any excess premiums and underwriting profits go back to the ownership.

There are several different captive models, each with their own unique attributes. Captive types include:

Single parent captives – sometimes referred to as “pure” captives, this is an insurance subsidiary of a parent company and is designed to cover the parent’s losses.

Group captives – this captive is a partnership of similar businesses, typically within the same industry. This model is often used when a single parent captive is too expensive to start up or premium volume is too low to make a single parent economically viable. Group captives provide risk coverage for all members of the group.

Association captives – similar to group captives, this model is typically owned and managed by an association, such as a professional or business organization.

Risk retention groups – established under provisions of the Federal Liability Risk Retention Act passed in 1996, this model allows several owners to create a form of group captive. Specific limitations apply to this model, particularly in the types of insurance lines they may write.

Rent-a-captives – this model allows companies to buy in or “rent” coverage from an established captive. Each renter gains valuable protection without the regulatory and financial burdens of forming their own captive.

Protected cell captives – similar to rent-a-captives, protected cell captives have multiple members, but the assets of each member is shielded from the others.

Benefits of Captive Insurance Solutions

As an alternative to the traditional insurance market, captives offer substantial advantages. There are five primary benefits of captives:

  1. Availability
  2. Control
  3. Transparency
  4. Cost Savings
  5. Stability

For high-risk businesses or those with unique or unusual operating environments, traditional insurance may be unavailable. Captives, then, represent a viable solution. Captives can be tailored to the unique risk exposures of a given individual business or group.

Because captives are wholly owned by an individual business or group, this offers a substantial amount of control in terms of coverages, costs, and flexibility. No longer are companies at the mercy of traditional insurers, with ever-changing policy limits and expenses.

Transparency is related to control. By owning and managing one’s own captive, the parent company or group can analyze claims data to improve performance. Transparency also provides a powerful risk management benefit to the company and those it protects with this self-insurance model.

Traditional insurance can be expensive. Premiums are on the rise across the insurance industry, positioning much coverage out of the reach of small business owners. Captives can help manage costs; once the start-up expenses are considered, operational costs can be fixed. If claims are low, the premium profits are returned to the parent company, providing significant income and tax advantages.

Finally, stability is an important part of captive insurance solutions. Traditional insurers may raise premiums, eliminate coverages, or lower limits based on market performance. Captives, on the other hand, provide a steady and sure solution, especially when loss histories and trends are analyzed.

Potential Drawbacks of Captive Insurance Solutions

As shown above, there are many advantages to the captive insurance model. Still, there are several potential drawbacks companies must be aware of before considering a captive as a valid insurance solution. Drawbacks include:

  • Entrance and exit barriers – starting a captive can be expensive. It can also pose significant challenges in terms of regulatory compliance and licensing. Leaving a captive plan can also be challenging, leaving some companies stuck with an existing captive until another alternative is identified.
  • Service and quality barriers – traditional insurers often have decades of experience in managing insurance products and services. Captives may not enjoy this same body of experience. Because the parent company or group is responsible for day-to-day management, captives can sometimes be at the mercy of the company’s own efforts – or lack thereof – in managing the plan.
  • Financial risks – a parent company or group puts its own capital at risk when establishing a captive. Members buying into a captive must also be prepared to invest their own assets. If an excessively high claim is made, or if multiple claims are made in a given year, that capital is at risk of loss, forcing members to scramble to find funding to cover losses.

Companies wishing to explore captive insurance solutions must carefully weigh many factors, including the advantages and drawbacks above. The captive insurance market is growing, but it is not the best solution for every type or size of business. With this information, you can better guide your clients in making informed insurance decisions, helping them determine if captives are right for their specific needs and risk profiles.

About Caitlin Morgan Captive Services

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.