Is the insurance industry ever going to catch up with the rest of the world’s growing trend toward innovation and flexibility in business? When it comes to business insurance options, a vital shift in the right direction has already happened—traditional insurance is no longer the only choice.
Captive insurance offers a unique alternative that puts the business owner in control of their risk management strategy. Of course, like any insurance option, captive insurance ownership has advantages and disadvantages. An informed decision on whether a captive best fits your business depends on understanding both.
At ReNu, we have built our business on understanding the intricacies of captive insurance. In this article, we share our insights into both sides—the pros and the cons—of owning a captive.
What are the advantages of owning a captive?
Some of the advantages of captive insurance ownership include:
- Customized coverage;
- Improved risk management;
- Stable costs and long-term savings;
- More straightforward regulatory requirements; and
- Access to valuable risk insights.
Customized coverage
Captive insurance enables customized coverage to fit each business’s unique risks. The captive owner designs coverage specific to their industry, operations, and risk appetite, paying only for the coverage they need without the gaps that may exist in traditional insurance. Comprehensive protection that aligns with an established risk management strategy saves money in the long run.
Improved risk management
With captive insurance, the business owner owns the company that insures their business. This gives the business owner direct control over risk and a strong motivation to manage risk effectively. Actively managing risk, implementing loss control measures, and focusing on risk prevention can potentially reduce the frequency and severity of claims.
Also, keeping a share of the underwriting profits from the favorable claims experience provides an extra incentive to prioritize risk management.
Stable costs and long-term savings
Unlike traditional insurance, where premiums can fluctuate, captive insurance offers cost stability. The captive owner’s renewal premium is based solely on their results, so if the owner manages their risk better, they will not only pay less for their coverage, but they can also accumulate underwriting profit.
Furthermore, as effective risk management strategies are implemented, and losses are minimized, premiums may even be reduced. These long-term cost savings and greater predictability for budgeting purposes can positively impact any business’s financial health and overall profitability.
With a well-run company and a robust risk management program, business owners can experience a 50% reduction in the total cost of risk.
More straightforward regulatory requirements
Like traditional insurance, captive insurance is subject to regulatory oversight. This means ongoing compliance obligations and reporting to the applicable state or offshore insurance regulator. However, because the scope of captive ownership or membership is significantly less complex than traditional insurance, the regulatory obligations are comparatively less cumbersome and more straightforward.
Access to valuable risk insights
One of the great benefits of captive insurance ownership is access to valuable risk insights. Captive insurance programs generate detailed claims data specific to each business’s risk profile. The data can be analyzed to identify patterns, trends, and opportunities for improvement, enabling informed decisions about risk mitigation strategies and prevention measures.
By understanding their business’s unique risks, the business owner can implement targeted risk management initiatives that minimize potential losses. This data-driven approach empowers continuous improvement and evolving risk management strategies over time.
What are the disadvantages?
Some elements of captive insurance ownership might be considered disadvantages and should be considered when deciding whether a captive is the best choice for a given business. The possible disadvantages include:
- Initial setup costs;
- Limited diversification;
- Potential liquidity concerns; and
- Exit strategy challenges.
Initial setup costs
Setting up a captive insurance company involves upfront costs, creating the need to budget for legal fees, funding collateral, administrative expenses, and professional services.
Limited diversification
Traditional insurance pools risk from a broader customer base. In contrast, captive insurance focuses on the risks associated with a specific business or a group of related businesses. Because this limited risk pool can pose challenges in terms of diversification, it may be necessary to consider reinsurance, which would add complexity and cost to the captive insurance structure.
Possible liquidity concerns
Captive insurance owners may face liquidity concerns if they experience a sudden surge in claims or catastrophic events. It is, therefore, important to understand the business’ maximum possible capital requirement based on any given policy year.
Exit strategy challenges
While traditional insurance allows for easy policy cancellations or switches, exiting a captive insurance program can be challenging. It may involve costs, potential loss of underwriting profits, and the need to secure alternative insurance coverage. These challenges create the need for careful planning and consideration.
Would captive ownership make sense for my business?
To make an informed decision as to whether captive insurance ownership is right for you, it is crucial that you:
- Carefully evaluate the circumstances, unique needs, and risk management goals of your business;
- Consult with an experienced insurance professional to learn about viable options; and
- Look at the advantages and disadvantages of each option.
Captive insurance ownership offers customized coverage, control over risk management, long-term cost savings, and valuable risk insights. At the same time, it also entails initial setup costs, regulatory oversight, limited diversification, potential liquidity concerns, and exit strategy challenges.
For more information about the financial advantages and disadvantages of owning a captive, we recommend that you read:
- What are the financial advantages of captive ownership? and
- What are the financial disadvantages of captive ownership?
Our insurance specialists are available to discuss any questions you might have.
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