Captive Insurance For Small And Mid-Sized Businesses

Several types of captive insurance companies exist, including pure (single-parent), association, group, and cell captives.

Captives can cover a range of insurance needs. Common coverages include:

• General Liability
• Workers Compensation
• Commercial Auto Liability with physical damage
• Large property schedules
• Auto Dealer Open Lot
• Garage keepers
• Professional Liability
• Medical Stop Loss

Yes. Combining captive and traditional insurance helps manage risk more effectively. Captive insurance covers a portion of the risk, allowing you to create coverage that fits your specific needs, manage costs better, and benefit from good claims experience.

To succeed in a captive, you need to adopt an entrepreneurial mindset. This means being motivated, forward-thinking, assertive, and innovative. You take ownership of your risks, engage in strategic planning, and implement creative solutions. Captive owners prefer control over their finances and risk management, avoiding the drawbacks of "class" underwriting where top performers are penalized for others' mistakes. The best captive owners are informed, prepared, and committed to investing time, energy, and effort to achieve profitability.

Captive insurers can benefit your business by providing customized coverage and financial control. This setup helps you avoid the pitfalls of the traditional insurance market, like paying for others' losses. Captives also encourage better risk management and can lead to long-term savings.

Group captive members typically pay annual casualty premiums of $475,000 (minimum $150,000), with many paying upwards of $2 million.  Typically, single-parent captives need $1 million minimum funding.  

If your business spends more than $150,000 annually on workers’ compensation, general liability, and auto insurance combined, you meet the minimum threshold for considering captive ownership.

If you spend nearly $1 million in premiums, a single-parent captive might be suitable for your business.

Yes, captive insurance can offer as much coverage as traditional insurance, if not more. Captive insurance provides premiums specific to your business's risks, eliminating coverage gaps often found in traditional insurance. This approach, combined with a solid risk management strategy, can lead to long-term cost savings and more accurate pricing.

Captive insurance offers significant financial benefits. By retaining underwriting profits and investment income, your business can improve cash flow. Those with good loss experiences might see a 28% reduction in renewal premiums within three years, plus an additional 25% potential for underwriting profit, leading to nearly a 50% reduction in the total cost of risk. Captives also allow owners to invest premium funds, potentially yielding extra income. Managing risks directly gives businesses control over insurance costs, enabling effective risk management and reduced claims frequency and severity for long-term savings.

Captive insurance presents several tax advantages:

• Premium Deductibility: Premiums paid to a captive insurance company are generally tax-deductible.

• Tax Deferral: Some captives allow for tax deferral on underwriting profits and investment income, which increases cash flow for reinvestment.

• Estate Planning Benefits: Captives can facilitate asset transfer, potentially leading to estate tax savings and smoother business succession.

Yes, captives can make your business more profitable by returning profits directly to the captive owner. This includes underwriting profits and investment income, which traditional insurance companies usually keep. Captives emphasize risk management and offer incentives for loss control, enhancing overall profitability.

Joining a captive involves significant financial drawbacks, such as:

• Capital commitment requirements
• Risk of capital loss
• Volatility in the reinsurance market
• Short-term cash flow constraints
• Potentially sub-standard investment returns
• Expenses associated with runoff
• Delays in collateral reclamation
• Challenges in achieving insurance accounting standards

In a captive arrangement, the owner provides collateral to safeguard against unexpected claims in the initial years. If claims exceed expectations and use up the collateral, additional capital may be needed to maintain solvency. While this is rare, it is a possibility.  In addition, if the business sustains multiple frequency losses (losses between $1-$100k) that exceed loss funding, the owner could be assessed up to one times an additional frequency fund, which equates to approximately 30% of your gross premium.  

Captive insurance requires policyholders to convert reserves into premiums paid over the twelve-month policy term, which can limit cash flow initially. However, the benefits of captive insurance often outweigh this drawback.

Captive insurance allows the insured parties to own and control the insurance company, whether it's a subsidiary of one business or a group of unrelated companies. Even though traditional insurance activities like policy issuance and claims processing are carried out, the insured retains control. This setup ensures that premium fluctuations are predictable, based solely on the business's losses, leading to year-over-year stability and more control over premiums. Captive policies are specific to the insured's needs, providing clarity on plan performance.

The risk committee assesses your profitability as a captive owner over the last five years. They look for a five-year pro forma and compare premiums against claim expenses. If premiums have consistently surpassed claim expenses, it indicates you can achieve profitable results as a captive owner.

If your company has a strong insurance history with premiums consistently exceeding claim expenses, the risk committee will review your risk management practices. Ideally, you should showcase established processes, procedures, and standards that reflect best practices. Businesses without documented risk management processes should establish them before applying to join a captive.

Choosing a captive insurance arrangement depends on the level of flexibility and capital investment you're comfortable with. A pure (single-parent) captive offers autonomy but requires more capital investment and collateral. Group member or cell captives involve aligning with other companies but may demand less capital.

Yes, exiting a captive is possible if circumstances change. However, captive ownership is a long-term strategy, and leaving requires careful consideration, similar to entering. Prospective captive owners should understand the exit strategy, especially in cases of failure or when the captive is no longer beneficial.

The biggest impact is your collateral obligation. The captive will require collateral until all claims and policy years are closed. This could take five to seven years from the date of exit.

Yes, if your performance doesn't meet the group's standards or if your business changes, you might be asked to leave a captive.  If you have continued frequency claims and fail to address the underlying problem, the remaining members will be paying for your losses.  Obviously, no one wants to pay for another member’s claims if the offending member isn’t rectifying the situation.