Before deciding to enter a captive, most business owners want to know whether and how they’ll be able to get out of it if things don’t go as expected. In simple terms, the answer is yes. You can exit a captive.
That being said, captive ownership is a long-term business strategy, and exiting should be given the same careful consideration as entering. It’s vital that as a prospective captive owner, you understand the exit strategy in case the captive fails or outlives its usefulness.
At ReNu, our goal is to be completely transparent about all facets of captive ownership, from entering to continued profitability and, of course, to exiting if that’s what the business owner wants to do. Our job is to make sure you have all the information you need to make the best decisions for your business every step of the way.
What happens if I want to exit a captive?
If the captive outlives its usefulness (for example, the underlying business is sold or becomes insolvent), the business owner may want to exit the captive.
If a business owner decides to exit a captive, they leave immediately. There is no obligation to stay or to continue contributing for any minimum period. However, exiting involves more than just ceasing to fund the captive or otherwise do business with it. It calls for careful thought and planning, and consultation with knowledgeable professionals.
One key thing to understand is that even though the business owner can leave immediately, the collateral they have invested stays in the captive until all policy years close–typically for five-to-seven years after the decision to exit.
The funds that were used to purchase the share are returned once all policy years are closed and any underwriting profit is distributed.
Why would there be delays in reclaiming the collateral?
With traditional insurance, the insured party simply pays their premiums without having to put up any collateral. That means that when the insured wants to exit from the insurance plan, there is no need to worry about recouping a capital investment.
In contrast, the captive insurance model relies on funds being immediately available to cover claims, carrying costs, etc., from the outset, which requires a capital investment from each member of the captive before premiums even start. That collateral could be put in jeopardy if the business owner is asked to pay an assessment, and the captive is still on the hook for the tail liability.
Also, if a business elects to exit the captive, the captive will still need to hold its collateral to cover the tail liability (that is, a liability that carries a long settlement period), which means it could take five-to-10 years before the collateral is returned to that business.
Every captive has a different version of what the collateral and the tail liability will look like, so it’s important to look at this part of the package very closely as part of the due diligence needed before committing to captive insurance ownership.
To have a better understanding of collateral and how it relates to captives, check out our video on the subject matter:
Why do some captives fail?
The two primary reasons why captives fail are related to undercapitalization and issues related to owner engagement (or, more specifically, lack of owner engagement!).
Undercapitalization
Undercapitalization occurs when a company does not have sufficient capital to conduct normal business operations and pay creditors. In the case of captive ownership, undercapitalization might be an issue if the business owner goes into a captive banking on their maximum investment will be the total of the minimum capital and surplus requirements, without allowing any room for changes to projected costs. This is a risky calculation, because depending on circumstances from year to year, all owners may be asked to put in more money for a given year.
Lack of owner-engagement issues
The second primary cause of a captive failing is the lack of engagement of the business owner(s), that is, the key decision maker(s). As a new company, the success of the captive depends to a great extent on the active engagement of its owners. Are the owners directly engaged in strategic decisions, continuous improvements, monitoring the risk management program, etc.?
If these and other decisions are left to other parties, such as the captive manager or other non-owner(s), then any resulting conflicts with the manager, regulators, reinsurers, etc., remain the responsibility of the business owner, when it is too late to make the required corrections.
How can I prevent my captive from failing?
As described above, it is certainly possible to exit a captive if you decide it isn’t as beneficial as you thought it would be, or if it otherwise just doesn’t seem to be the best option for your company after all. But all things considered, if your captive is profitable, exiting will be the last thing on your mind.
The best way to prevent a captive from failing is to run a thorough analysis of your risk management program and your insurance history, and the best way to do that is through the right captive underwriting process.
To find out about how to prepare for profitable captive ownership, be sure to read What is the best way for a business to prepare for the captive underwriting process?
At ReNu Insurance Group, our insurance advisors are available to discuss any questions you might have.
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