As the insurance market tightens, companies and professionals may be discovering that fewer carriers are willing to provide coverage, and that available policies may carry higher costs for coverage that may not seem to be as broad or palatable to organizations. If you or your business has shopped for coverage recently, you may have found the process frustrating.
If your organization is part of an association or an affinity group (i.e., a group of organizations with similar risk profiles and goals), you may be able to obtain better coverage for your specific risk needs at a more efficient cost than you’ll find in the traditional marketplace by creating an alternative: a captive.
How Captives Work
In simple terms, a captive is an insurance company created specifically to insure the risks of its owners and serve the needs of a specific group of insureds, such as an association or an affinity group. The captive is completely funded, owned and controlled by the organizations that benefit from its existence. Creating the captive gives them an alternative to purchasing insurance on the open market and allows them to tailor the coverage to the specific risks associated with their operations.
For example, individual owners of quick-service restaurant franchises need to purchase property and casualty coverage. Like most business owners, they engage insurance agents to find suitable policies at the best price. Because each franchise is buying separate policies from different carriers, the quality of coverage may vary significantly and, given the lack of buying power, they’ll probably pay a hefty price for it.
Suppose 100 of those franchise owners band together and create their own captive insurer. They work with a consultant to identify the risk profiles associated with the nature of their business and develop a policy that actuarily reflects those risks. All 100 franchise owners invest in the captive company. Instead of paying for insurance as a business expense, they’ve essentially put part of their capital at risk in addition to insuring their risk in a captive. In most cases, the cost of insuring risk through a captive is much lower for the long term than it would be to purchase insurance individually. The group buying power of the 100 franchise owners commands more attention and drives down price with the use of a captive insurance company.
In addition, those traditional insurance premiums are a recurring business expense, while any capital and premiums invested in a captive that aren’t paid out as claims become reserves that can grow through investment earnings. If the claims activity is less than expected and the reserves are prudently invested, owners of the captive may be able to contribute less in future years.
Who Can Form Captive Insurance Companies
Captive insurance companies can be developed for any kind of association or affinity group. A state association of manufacturers could establish a captive for its members. A group of Indian-American small-business owners or Latino primary care physicians could do the same. Flexibility is one of the primary advantages of this approach. The captive insurer can be created to cover all losses of a particular type up to the amount agreed upon by the owners, and reinsurance and/or excess insurance can be secured to protect the captive’s balance sheet.
Creating and administering a captive insurance company requires specialized expertise. After all, it involves forming a licensed, regulated insurance company that must be properly filed with state and/or national governments and will be expected to meet reporting and reserve requirements. An experienced partner like Hylant’s captive team can help your organization evaluate the costs and benefits of the captive approach, and guide you through every step of the process.
The above information does not constitute advice. Always contact your insurance broker or trusted adviser for insurance-related questions.