More than a fair share of business owners like yourself are aggravated with the traditional insurance market. You’re dealing with a lack of transparency, increasing premiums upon renewal season, and little to no control over your policies. To call it frustrating is a severe understatement.
Captive insurance is a long-term plan that can help alleviate these issues. That said, captives aren’t for everybody. It’s important to figure out if it’s the best choice for your business.
At ReNu Insurance Group, we understand the ins and outs of captive insurers, especially when we’ve helped over 130 businesses become captive owners. While we can identify the ideal captive owner, we also know when businesses aren’t the best fit for captives.
In this article, you’ll understand the fundamentals of captive insurers, their advantages and disadvantages, and how to determine if they’re right for your business. That way, you can be a step closer to knowing if they’re a good fit for your business.
Table of contents:
- What exactly is captive insurance?
- How do I determine if captive insurance is right for my business?
- What are the Advantages of Captive Insurance?
- What are the Disadvantages of Captive Insurance?
- Common misconceptions about captive insurance
- So, do you think captives are good for your business?
What exactly is captive insurance?
Captive insurance is a form of self-insurance where the insurer is wholly owned and controlled by its insureds to cover its risks. Unlike traditional insurance, where you pay premiums to a third-party insurer, the captive insurance model allows your business to create a subsidiary that provides insurance coverage.
Here is a brief rundown of the different structures:
- Single-Parent Captives—This is an independent insurance entity established by your business (aka the parent) to cover and manage risks.
- Group Captives—In this model, multiple businesses share risk profiles, pool resources, and manage risk. These captive models can be homogenous (with the same lines of business) or heterogeneous (with unrelated businesses).
- Cell Captives—Multiple entities share a common insurance structure but maintain individualized risk strategies within their own segregated cells.
- Medical Stop Loss for Employee Benefits
To better understand these different structures, read our articles on Single-Parent Captives, Group Captives, and Cell Captives.
For additional information on captives and how they work, download our guide that gives you a rundown on how captives benefit businesses!
How do I determine if captive insurance is right for my business?
Determining if a captive insurance company is the best choice for your business isn’t easy. We wish we could tell you it is. However, we can provide you with more tools, information, and resources so you can determine if captives are right for you.
Here is some more information to consider:
- Annual Insurance Spend—Captive insurance is typically more suitable for businesses that spend AT LEAST $250,000 annually on combined premiums for workers’ compensation, general liability, and auto liability.
- Entrepreneurial Mindset—Businesses with an entrepreneurial spirit that are open to innovative solutions, increase control over their risk, and seek ways to reduce costs are ideal candidates for captive insurance.
- Frustration with Traditional Insurance—Traditional insurance might be a good fit for some businesses, especially those that view insurance as purely transactional. Most people looking at captives tend to be dissatisfied with high premiums and lack of transparency in the traditional market.
- Commitment to Risk Management—Captive insurance works best for businesses that prioritize safety and risk management. Being on top of risk management helps directly with lower claims and reduced insurance costs.
- Desire for Control and Transparency—If having control over your insurance operations and understanding exactly how your premiums are used is important to you, transparency is definitely something captives offer.
- Industry Fit—Captive insurance is beneficial for businesses with significant risks. These are businesses such as those in transportation, manufacturing, and distribution. However, industries like legal services can benefit, especially for covering professional liability.
What are the advantages of captive insurance?
- Control and Transparency—Unlike the traditional market, you have more control over your insurance program. You have more autonomy over your claims handling process, underwriting standards, and risk management strategies. You have a direct impact on your insurance outcomes, and you know where every dollar of your premium is going.
- Potential Cost Savings—One of the biggest financial advantages of captives is that businesses generally see a reduction in their insurance costs over time. On average, businesses experience a 28% reduction in premiums (assuming no changes in loss history) within the first two to three years after entering a captive. Additionally, as your business focuses on effective risk management, the total cost of risk (not just premiums) can decrease by up to 50%.
Something to note: Businesses will incur a significant loss once every five or six years, even with the best safety and risk management programs.
- Stability—Captives can provide more stable pricing compared to the traditional insurance market, which fluctuates. Captives are a long-term risk strategy rather than a short-term profit plan, which allows stability.
- Customized Coverage—Captives offer more flexibility, so you can have insurance coverage that meets your business's needs. This is beneficial for businesses with unique or high-risk profiles that may not be covered by traditional insurance policies.
- Profit Retention—Any underwriting profit generated by the captive is retained within your business rather than going to a third-party insurer, which can be a financial advantage for your business.
You might be wondering if you can reap the rewards of the financial advantages captives offer. Take this assessment before continuing to see if you can profit from a captive.
What are the disadvantages of captive insurance?
While captives certainly have their fair share of advantages, there are some downsides for you to consider:
- Initial Costs—Let’s be real: the initial costs aren’t exactly cheap. Setting up a captive insurance company or joining a group captive is expensive, which can be a financial disadvantage. This includes feasibility studies, regulatory compliance, and collateral requirements. For instance, your collateral—a line of credit or cash to secure funding for claim payment—could be as much as 80% of the full amount of your initial premium.
- Long-Term Commitment—Again, captive insurance is a long-term business strategy. If you’re looking for something quick and easy or view insurance as a transactional expense, captive insurance likely isn’t for you. While it’s possible to exit a captive, it involves careful planning. Plus, the invested capital stays with the captive until all policy years are closed.
- Regulatory considerations—The IRS needs to recognize that you’re going with true notions of insurance. The last thing you want is for the IRS to be down your throat and hate you.
The regulatory environment varies depending on the captive's domicile, which could be offshore or in specific U.S. states. Each jurisdiction has its own requirements for meetings, reporting, and compliance.
As the saying goes: “If you’ve seen one captive, you’ve seen one captive.” Yes, you read that correctly. Every captive is unique in their requirements and how they operate.
- Operational burden—Managing a captive requires dedicated resources and expertise in risk management and insurance. All of the day-to-day decisions are made by the captive manager. You must attend two board meetings per year and risk workshops. Captives may not be the right fit if you aren't interested in participating or can't send someone in your place.
Common misconceptions about captive insurance
You’re likely to hear various misconceptions or concerns about captive insurance. They can be daunting to hear, especially when you’re already trying to figure out if captives are a good idea for your business. Here are some common misconceptions to address.
- “My business isn’t big enough for a captive.”—This isn’t the case, especially nowadays. Compared to back in the day when captives were for Fortune 500 companies, they’re more accessible than ever for small to mid-sized businesses. With structures like group captives, smaller businesses can pool their resources together.
Again, if you spend at least $250,000 in insurance premiums annually, you’re big enough for a captive insurance company.
- “A large claim will bankrupt us.”—Properly structured captives are designed to handle large claims without bankrupting your business–or the captive, for that matter. Risk is spread across all members in the captive, which puts a buffer against significant loss. And if you own a single-parent captive, they’re prepared for the worst-case scenario if you happen to face a catastrophic loss.
- “We’ll save a ton in taxes.”—If your primary goal is to get into captives for tax purposes, you may want to consider alternative insurance solutions. Sure, while they can have tax advantages, they should never be the primary reason to become a captive owner. The main benefits come from improved control, transparency, stability, and cost savings.
- “We’ll lose the protection of a traditional insurer.”—This isn’t the case. Captives are designed to offer your business the same protections a traditional carrier would. They can also include reinsurance from the traditional carrier (names you already know) to cover catastrophic claims.
Read our article Top 3 Misconceptions About Captive Insurance Companies for a more in-depth understanding of how these misconceptions are irrelevant.
So, do you think captives are good for your business?
Captive insurers are effective for businesses looking to take control of insurance costs and risk management. They offer transparency, potential cost savings, and customized coverage. However, they don’t work for everybody. They’re a long-term commitment that requires an entrepreneurial mindset and a proactive approach to risk management.
While you understand how captives can be a good idea for your business, you should read our article Pros and Cons of Single-Parent and Group Captives to understand each captive structure, their benefits, and their drawbacks.
If you are unsure how much you would have to invest into a captive and the underwriting profit your small business can make, use our pricing calculator to get your results.
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