The traditional insurance market is filled with complexities and limitations that take time to navigate. That’s for sure. The conventional approach to insurance might not offer the control and transparency you crave, making you say to yourself, “There’s gotta be something better for my business. But are captives riskier than traditional insurance?”
Thankfully, you have expertise through us at ReNu Insurance Group, who have helped over 130 businesses become captive members. We are committed to ensuring that you have the whole picture so you can make a fully informed decision as to whether captive ownership is a viable option for you.
In this article, we’ll lay out the risks of joining a captive compared to a traditional insurer. That way, you can be closer to deciding if captives are the best fit for your insurance needs.
Are captives riskier than traditional insurance?
Yes. Captives are riskier than traditional insurance. But if you’re prepared to take and manage that risk well, you can reap great rewards!
Check out our video on how captives are riskier compared to traditional insurance:
The captive insurance option gives businesses more control and transparency regarding their insurance coverage and premiums. Still, many business owners may hesitate to explore this option due to concerns over risk without taking a closer look at what that means and whether the potential benefits might offset the potential risk.
Note: There are many variations in how captives are formed, even within the individual captive types. This article uses the group captive model as the comparative model.
Where exactly is the risk with a captive?
With traditional insurance, the insurance carrier assumes all risks and retains all the profits. This model is based on the principle known as “traditional risk transfer (TRT),” where the insured pays premiums to transfer risk to the third-party insurance company.
With captive insurance, the captive owns their own risk. As a stand-alone statement, that sounds terrifying. But as with most comprehensive models, it doesn’t make sense to take that statement on its own without looking at it in context and putting it into perspective.
With a group captive, the members share in the risk, and they also share in the potential reward of lower costs, underwriting profits, and investment income.
While a captive offers greater transparency and control over premiums, it also requires significant upfront investment and ongoing management, all overseen by a risk committee dedicated to ensuring the captive works.
The two primary reasons captives fail are undercapitalization and issues related to owner engagement (or, more specifically, lack of owner engagement).
Is there any single factor that impacts the level of risk with a captive?
The bottom line is that the risk of joining a captive is directly related to how informed and prepared the business owner is. Just as importantly, the level of risk can fluctuate depending on how ready the business owner is to invest the time, money, dedication, and engagement it takes to build, maintain, and continuously improve a risk management program that meets the high standards expected of a captive member.
You might be wondering how your business would do as a captive owner. Take your captive assessment to get your results and see how much you can save on premiums.
What does the business owner need to bring to the table?
A successful captive owner is generally a business owner who:
- Understands risk financing;
- Can deploy capital in case loss funding is insufficient (generally an additional 20-40% of the premium);
- Has a better-than-average loss history, or is willing to invest in effective risk management;
- Spends enough on premiums and/or losses to offset the operational costs of the captive (costs dependent on the captive’s actual risk financing arrangements); and
- Needs access to specialized capacity (i.e., reinsurance).
I think I can do this…what else do I need to know about captives?
Ultimately, the decision of whether the potential risk of owning a captive insurance program is greater than the benefits of reclaiming control from your traditional insurance program depends on your specific needs and circumstances.
As with any big decision, it's essential to weigh the pros and cons of all the options, then consider factors such as budget, risk tolerance, long-term business goals, and, more simply, whether you’re ready to join a captive.
To learn more about the pros and cons of captive ownership, be sure to read: What are the general advantages and disadvantages of captive insurance ownership?
And if you're wondering how much you would need to invest and how much you can make in underwriting profit, use our insurance calculator!
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