Insurance plans can be a complex and overwhelming topic, especially when it comes to deciding between different options. It feels as though rocket science is easier than navigating insurance plans. If you’re like some business owners, you may be thinking that it would be easier just to stay where you are, pay a higher deductible so you can pay lower premiums, and then hope for the best.
The reality is that high deductible plans and captives each have their own set of advantages and disadvantages depending on the specific needs of your business. Fortunately, at ReNu Insurance Group, we have made it our mission to take the guesswork out of this important part of your risk management decision. We’ve helped take the guesswork away for over 130 other captive owners.
In this article, we will compare captives with high-deductible plans. That way, you can decide which method is best for your business. With this insight, you’ll be in an excellent position to look at the financial advantages (and disadvantages) of captive insurance ownership.
What are the pros and cons of the high deductible insurance plan?
A high deductible plan involves paying an external carrier a monthly premium at a rate based on the loss histories of a particular business and requires that collateral be set aside so that the funds to pay the deductible are available in case of losses. The deductible can be quite large, meaning the insured party must be willing to risk larger losses in exchange for a lower premium.
However, if the insured has no claims, this approach can significantly lower the total cost of insurance, and the insured company is not tied to the insurance program year over year.
Pros of high deductible plans with lower premium cost
There are several advantages to paying a high deductible with lower premiums, including:
- ownership of risk
- lower up-front premiums
- immediate rewards, and
- increased freedom.
Ownership of risk—when a business has to put out significant money with every loss, the goal is to create more robust safety and risk management programs to prevent those losses from happening again. In general, this increased ownership of risk tends to produce better safety performance.
Lower up-front premiums—by committing to a significantly higher deductible, the business assumes a portion of the risk so that its insurance premiums will be lower. However, the premiums are still set by the carrier and are NOT solely based on the specific loss experience of the insured party.
Immediate rewards—if the insured performs well, they won't have many claims that need to be paid out of pocket. And if what a company is paying in deductibles is less than what they were paying for their higher insurance, they will be financially further ahead.
Increased freedom—the insurance carrier may be willing to allow a client with a substantial deductible to have more flexibility on claim settlements or even use a third-party administrator (TPA) to handle claims.
Cons of high deductible plans with lower premium cost
The disadvantages of relying on high-deductible coverage with lower premiums include:
- Less financial certainty.
- The need for collateral to fund claims.
- Lack of control over premiums.
Less financial certainty—if a business has frequent large claims, then a high deductible can have a significant negative impact on its bottom line.
Collateral—with a high deductible, the insurance carrier will want financial certainty that the insured can pay that deductible if they have to make claims. This typically means that the insured business will need to commit additional collateral to fund claims.
Lack of control over premiums - No matter how low the premium may be, the carrier is still in control of the rates. If losses exceed the deductible or the class of business becomes unfavorable, the insured has no control over the rates a carrier may charge. It's up to you to see if the higher deductibles are worth the potential premium hike.
Comparing captive insurance to high deductible plans
On the other hand, group member captives allow the business owner to own their insurance carrier. Their premium is determined by their own performance, with a strong emphasis on safety and risk management.
Premiums are stable because they are based solely on the performance of their own business, and they benefit from complete transparency as to where every dollar of their premiums goes.
At the same time, collateral requirements and loss sharing are absorbed in the total insurance cost.
Pros of captive insurers
Compared to the high deductible/low premiums approach, some advantages of captive ownership include:
- investment income;
- tax advantages;
- ownership mindset, and
- building net worth.
Investment income—captive owners typically earn investment income on their premiums and on any cash collateral that is deposited on behalf of the owner.
Tax advantages—captives usually fund anticipated losses up-front through premiums. Premiums can then be expensed, decreasing any pre-tax profit.
Ownership mindset—with an external insurance provider, the business owner still doesn’t own their insurance even if paying for a high deductible plan—they are merely renting insurance from the carrier. As part owner of a captive, each captive member owns their own risk and participates in any profit or loss. This ownership typically influences their safety culture and sense of accountability.
Building net worth—underwriting profits are typically left to accumulate in a tax-advantaged location for years. This means that a sustained run of excellent performance can result in building a substantial amount of profit for the captive owner.
To learn more about the financial advantages of captives, you need to watch our video about this very subject:
Cons of captive insurers
Some disadvantages of choosing captive ownership rather than the high deductible/low premiums approach include:
- investment capitalization, and
- risk sharing
Investment capitalization—the captive needs to be capitalized before it can operate as an insurance company. The capital investment can be substantial and will need to be kept in the captive for years.
Risk sharing—unless a business is in a single-parent captive, they share a portion of the loss experience with other group members. This works well when the majority of members perform well, but if there are years when multiple members perform poorly, the burden is shared by the group.
And like with our video on financial advantages, you need to check out our video on financial disadvantages:
What are the financial implications of captive ownership?
There are pros and cons to both high deductibles and captive ownership. Each business owner is encouraged to consider all aspects carefully before committing to either option, being careful not to confuse the financial instrument with the long-term strategy.
To learn more about the differences between high-deductible plans and captives, check out our video:
To learn about the financial pros and cons of captive insurance ownership, you need to read these two articles:
- What are the financial advantages of captive insurance ownership?
- What are the financial disadvantages of captive insurance ownership?
Our insurance specialists are available to discuss any questions you might have.
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