Captive insurers aren’t as well known to many business owners, let alone insurance agents. As you’ve learned more about captives, knowing there’s potentially more than one option for your business makes things more confusing.
Thankfully, ReNu Insurance Group knows all about captives, especially after helping over 130 captive owners. It’s our job to know what kinds of captives are best for certain businesses.
In this article, you’ll understand the differences between single-parent and group captives. That way, you’ll know what type of captive is best for you and your business.
Discussing fronting carriers before talking about captives
First off, what is a fronting carrier?
When captives need to participate in the risk and premium of standard commercial coverages, they often engage with “fronting carriers.” Fronting carriers are “traditional” insurance carriers that will allow captives to use their paper (AM Best rating, financial size, etc.) in exchange for a small portion of the premium (typically 15% of the gross written premium), collateral for credit risk. Then, they transfer the risk and premium to the captive.
Even the world's largest companies must adhere to regulatory requirements and terms and conditions that govern lender/vendor/customer agreements. These requirements often contain insurance requirements that would prohibit a captive from writing coverage directly to an insured business without using a fronting carrier.
Single-parent captives cost more
The biggest difference between a single-parent vs. a group captive is how much you pay in premium. The industry sees $1,000,000 as a minimum for a single-parent captive.
If you’re spending less than $1M for coverage on workers’ comp, general liability, and auto, creating a single-parent captive won’t make sense for you.
Here's why: most captives and traditional insurance companies run on a 60/40 split, with 40% covering basic expenses (i.e., paying captive manager, actuary, domicile requirements, attorney, etc.) and 60% going to the loss fund (i.e., money reserved for claims).
Because your state auto and work comp financial responsibility laws require "A" rated paper, the fronting carrier will need approximately $150k. This increases your expenses (lowers your loss fund) in such a way that the captive is doomed before it even starts. There would not be enough money in the loss fund to pay future claims.
Pros of single-parent captives
What’s awesome about single-parent captives is you don’t have to share. Your business typically has enough risk distribution (sharing risk amongst your various entities) or has enough units that the IRS would agree your captive is indeed a true insurance company. You can better customize your insurance to ensure it’s tailored to the needs of your business.
You are your own master. A strong, independent captive that doesn’t need other businesses to function. You have control over everything.
You’ll have the fronting carrier on some things, but you’re in charge. It is real insurance, meaning you’ll have to do all of the regulatory filings of an insurance company.
When you join a group or create a single-parent captive, the regulatory filings are typically done for you by a captive manager. Typically, single-parent captives will have a lower expense ratio and, thus, a higher opportunity for underwriting profit. Obviously, profitability depends on claims in a given year.
Cons of single-parent captives
Depending on how the captive is set up, you want to be careful not to have a couple of large losses that can bankrupt your captive. There isn’t anyone to share risk with as you have with a group captive.
You will either need a fronting carrier and/or reinsurance. That way, your captive can still be funded if you have a loss or multiple losses. You don’t want to blow it up the first couple of years before you get any surplus.
Note: The first couple of years of any captive is the danger zone. It hasn’t achieved enough mass or momentum to keep everything going. Significant losses affect your momentum.
You need to know that even though you’re the cool kid on the block with a single parent captive, someone is always watching, especially the regulators and the fronting carrier.
Group captives require less premium to get started
With a group captive, the minimum required premium is much less than a single parent, starting around $250,000. In addition, the start-up costs are also spread across the various members, which lowers the initial cost of joining compared to footing the entire bill as a single-parent captive.
As a member, you have partial ownership but don’t have full ownership like you do with a single-parent captive. However, you have to be big enough to get a seat at the table. This means you’re spending at least $250,000 on workers’ comp, general liability, and auto liability combined.
Pros of group captives
Group captives have become more prevalent as business owners realize they don’t need to be stuck in the traditional market, can finance their own risk, and can reap the benefits of managing their safety and risk management programs well. While you don’t have as much say or leeway as a single-parent captive, you are a partial owner with some say. You’re sitting at a table with the other big kids during Thanksgiving.
It’s a good paradigm to know how you buy insurance, especially when sharing risk with unrelated entities with the same interest as you. They allow you to take a bet on yourself and still have the protection of a traditional insurance carrier.
There is also a sense of camaraderie from other members depending on which group captive you join. More than just the profitability and being self-insured, there’s also the risk management side.
If you’re in a homogenous captive (as in, with similar classes of business), you can get advice on how to manage risk better and have best practices. It is the same with heterogeneous (businesses from other industries), though the advice may vary from industry to industry. Regardless, you all work together to minimize your risk. Ideally (and in practice), you all want to be safer, more efficient, and better.
If you go with a group captive, you need to know the details.
- Who’s the captive manager?
- What are they doing with the captive?
- What’s their goal?
- How many members are there?
- Ultimately, what is the culture of the captive?
- Am I a fit for this culture?
With risk sharing, there is less of a chance your business or any of the others involved will cause the captive to collapse. Every business will have one bad year out of five. That’s how it goes, even with the best safety and risk management in place. And thankfully, everyone wants to minimize risk as much as possible. If they didn’t, you could kick them out of the group captive.
Regardless of any captive you decide to join or create, you have to have the three things:
- You need to be entrepreneurial.
- You need to make risk management and training a priority.
- You need to have a culture with a belief system that the changes you make can affect different outcomes.
Know the financial pros and cons of captives
Captives come in all shapes and sizes depending on the size of your business. It’s good to know which type of captive works for you. And you’ll also want to learn about the financial advantages and financial disadvantages. Captives come with financial risk. So, make sure it’s something you want to dive into.
And if you have 30 minutes to spare, you need to read our free pocket book How to Self-Insure Your Business in 90 Days Without Sacrificing the Protection of an Insurance Carrier. That way, you can understand how to be a captive owner within three months.
And if you have more questions about captives, don't hesitate to schedule a call with ReNu Insurance Group. Understanding Captives can be difficult. Talking to an expert can quickly clear up questions or concerns you have.
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