Any business owner shopping around for insurance policies needs to know that there is a real alternative to the traditional insurance model.
Captive departs from traditional insurance in several ways, and one of the fundamental differences is the way the policies work. Important differences show up when we look at any of the key aspects of the respective policy frameworks, from control, stability, and transparency to relative risk and reward, to the ease of getting started and overall flexibility.
As more and more companies turn to captive insurance, ReNu continues to build our own business by staying in tune with the ever-evolving captive landscape and sharing our extensive insight with other businesses. This article will give you a good idea of how a captive policy might differ from that of a traditional insurance policy. From there, you will be in a good position to learn about how the captive underwriting process works.
For our more visual learners watch our video on traditional and captive insurance policies.
Control—who is in charge of the insurance contract?
How much control do I have with a traditional insurance policy?
With a traditional insurance plan, a third-party company creates and controls the insurance contract. The external provider charges a premium for the policy, and the insured company pays a deductible. The premiums paid by each insured business pool with premiums from various other businesses and their insured risks, and if a claim is incurred, the insurance at least partially covers the claim.
How much control do I have with a captive insurance policy?
With a captive insurance plan, the insured parties own and control the insurance company. It is typically created as a subsidiary of one business, or several unrelated companies may create a group captive to disburse their risk. In either case, the insured party or parties retain control, even while the captive program carries out the same activities as a traditional insurance program, including issuing policies, processing claims, abiding by regulations and compliance requirements, filing income tax returns, and creating profits.
Stability—can I expect an insurance premium increase?
Traditional insurance premiums are less predictable with cost increases
Buying traditional insurance means a 100% transfer of risk. The carrier covers the entire established risk up to the established limit for the policy, which means they—this external third party—are in the driver’s seat. Like any other business, they need to make a profit, and to do this, they can adjust premiums as they see fit from year to year—or even unilaterally decide to cancel coverage—based on the outcomes of other parties they are insuring, or decisions that have nothing to do with the individual insured or their loss history or profitability.
With the traditional model, there is simply no way to predict what premiums will look like after the first year, zero year-over-year stability, and a high potential for significant instability. Essentially, the risk coverage of the business is subject to the whim of the insurance company.
Captive insurance policy increases are based on your losses
Buying with captive insurance still means transferring risk to an insurance company, and the captive covers risk up to the established limit for the policy, but the business owner owns more of their own risk.
At the same time, premium fluctuations are more predictable because the business owner is only subject to—and premiums are based solely on—their own losses. This provides for significantly better year-over-year stability, continued owner control of the premiums, and no unsupported changes.
Transparency—do you know how your premiums are being spent?
You don't know where your money goes with a traditional policy
With traditional insurance, the insured party has no idea how their premiums are being spent or where the money they put in goes.
You know where every penny goes with a captive insurance policy
With captives, the policy is written to meet the specific needs of the insured, and the business owner knows exactly how their insurance plan is performing at all times.
Relative risk and reward—is there any option to assume more risk in the hope of reaping higher rewards?
Traditional policies are safer, but offer less reward
With traditional insurance, the carrier takes on all the risk. They calculate the premium price based on risk probability according to a large pool of insured risks, and they (and their shareholders) keep the profits whether any claims are made against the policy or not. In addition, the traditional carrier can increase the premiums based on historic loss or higher perceived risk.
That said, there are methods in the traditional market that transfer more risk to you in exchange for a lower premium. Even then, increases in your premium can still occur upon renewal season.
Captive policies are high-risk, high reward
In contrast, captive owners can decide whether or not to reserve or distribute the captive’s profits. In exchange for the additional risk, the captive owner has the potential reward of reduced costs, underwriting profits, and investment income.
This is particularly advantageous for a business that has strong risk management policies and a positive claims history. Businesses that can control their losses are financially rewarded.
How easy is it to get started?
Traditional insurance policies are easier to get started with
Setting up a traditional insurance policy entails low start-up costs because there are no fees to form the company, legal fees, or capitalization requirements. The business owner just shops for the ideal policy from an established entity, purchases the policy, and then relies on the external, third-party insurer to manage the daily operations of covering their risk.
Captive policies take more time and effort
With the captive model, setting up the policy is more hands-on because it needs to be tailored to align with specific risks associated with the business. The captive often takes longer to set up, and the business may incur some initial fees and funding requirements at the outset. That being said, the benefits of joining a captive can be expected to mitigate many of these early costs.
How flexible is the policy? For example, can you control the coverage design or select terms?
Traditional policies are generally less flexible
Traditional insurance plans are designed to cover as many people as possible. However, these plans tend to be generic, and their coverage can be limited to only certain types of risk.
A captive policy has more flexibility for your business
On the other hand, captive insurance provides more flexibility and customization. The business owner has more control over the coverage design and can select the terms and tailor the benefits to align with their company’s specific business risks and employee needs.
How are captive policies established?
The policy features of captive insurance ownership are yet another difference that makes captive an attractive alternative to traditional insurance plans for many business owners. However, before deciding whether this option is right for your business, you will need to understand what goes into setting up a captive policy.
For insight into this important part of the equation, read:
Our insurance advisors are available to discuss any questions you might have.
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