Listen, we know how frustrated you are when facing high insurance premiums when reaching renewal season. Shopping in the traditional market can be infuriating. It certainly doesn’t help with insurance costs for your small business. No matter how good you have been to have zero claims, it feels like the insurance industry punishes your small business.
One good alternative to consider is captive insurance, especially if your business has few to no claims.
At ReNu Insurance Group, we’ve helped over 130 businesses become captive owners. We understand the benefits small businesses have seen when going from the traditional market to captives.
In this article, you’ll learn about captives, their benefits, financial implications, and challenges to consider. That way, you’ll have a better understanding of whether or not your small business is a good fit for captives.
For clarifying purposes, we’ll define “small business” by premium size. Consider yourself a small business if you’re paying $250,000 to $600,000 for workers’ comp, general liability, and auto liability.
What is captive insurance?
Captive insurance is an alternative to traditional insurance, where a business forms its own insurance company to cover its risks.
In the traditional insurance market, premiums are paid to a third-party insurance company that controls what you pay and takes the entire underwriting profit. With captive insurance, your small business can earn the underwriting profit and manage your own risk.
In the traditional market, there’s no incentive for you to do better, especially when you still see premium hikes while having zero claims. There’s no incentive for them to give you a better deal. Where traditional markets are unpredictable, captives bring predictability. A captive structure would incentivize your business to implement and strengthen your risk management strategies because better performance and fewer claims directly impact your insurance costs.
While there are variations, structures, and rules in how each of these captives operates, most cover workers’ comp, general liability, and auto liability for your business.
Types of captive insurance companies
There are three types of captives that businesses find themselves a part of. Some are less suitable for small businesses compared to others depending on the amount of premium paid:
- Single-Parent Captive—This type of captive is wholly owned and controlled and provides insurance for that one business. Creating this type of captive would require at least $1 million in insurance premiums being spent for your business.
- Group Captives—This type of captive is an insurance entity shared by businesses with similar risk profiles. Your business and others would pool resources and share risks. This option is great for small businesses looking to self-insure. This is a great option for your business if you’re spending at least $250,000 in insurance premiums.
- Cell Captives—Multiple businesses share a common insurance framework, each with its own segregated “cell” for managing risks. You’ll receive cost savings and regulatory flexibility, but it won't provide the level of control for your small business compared to other types of captives.
To better understand these different structures, read our articles on Single-Parent Captives, Group Captives, and Cell Captives.
How can captive insurance benefit my small business?
While captives can be more work compared to paying a traditional insurer and moving on with your day, captives have benefits for the work put in:
- Cost Savings: Your business can see a reduction in insurance costs over time, especially when you can keep claims to a minimum. Your good performance can bring reduced premiums and underwriting profit. So you can see an increase in cash flow.
- Control and Transparency: With captive insurance, you know where every cent of your premium goes and how risk is managed. You have a direct say in the risk management strategies and can see where your money is going.
- Stability: Your premium cost is more predictable, which is crucial for a small business owner. If your cash flow is tight, the last thing you want is a surprise increase when renewal season comes.
- Incentives for Risk Management: Captives are all about reducing risk by enhancing your safety and risk management programs. And you have a strong incentive for this too, especially when it means financial benefits.
You might be wondering how captives can benefit YOUR small business. Take this assessment to see how you can profit from a captive.
What your small business needs to consider financially
Entering a captive insurance arrangement has initial costs and a commitment to managing risk effectively. Here are some financial aspects to consider:
- Initial Investment: You will need to invest in forming or joining a captive. This can include a share purchase, collateral for potential claims, and administrative costs. For a group captive, the initial costs can range from $25,000 to $50,000 for the share, plus additional funds for collateral based on expected claims.
- Ongoing Costs: When you pay your premium into a captive, they’re used to cover claims and administrative expenses. These premiums are typically lower than traditional insurance premiums over the long term, especially if your business maintains a good claims record.
- Risk Management Fee: You might also have to pay a risk management fee, which is usually a percentage of your premium. This fee supports the captive’s operations and ensures proper risk management practices.
Challenges and considerations for your small business
There are plenty of benefits your small business will see. With all this said, there are potential challenges for you to consider.
- Regulatory Compliance: You need to comply with regulatory requirements captive insurers offer, which vary by domicile.
- Risk of Claims: You need to be prepared for potential claims and have the funds set aside to cover them. You will have a bad claims year once out of every five or six years. In a bad claims year, you may have to pay an assessment because the captive’s reserve funds are depleted. Additional capital will be needed.
- Commitment to Risk Management: For success in a captive, your program requires you to have effective risk management programs. Businesses that fail to manage their risk face financial penalties. And if you’re careless about your risk management, you can be asked to leave the captive.
Are you considering captives for your small business?
Captives can be an effective long-term tool for the needs of your small business. If you’re looking for control and transparency over your insurance, captives might be perfect for your small business. You need to weigh the benefits, financial considerations, and challenges to see if they’re right for your small business.
Next, read our article Is Captive Insurance Right For My Business? That way, you can better understand different types of captives, their advantages, disadvantages, and misconceptions about captives.
If you're wondering how much you can save with a captive insurer, use our pricing calculator to determine how much you can save, your underwriting profit, and maximum out of pocket in a bad claims year.
Topics:
