7 Ways Captive Insurance Companies Provide a Competitive Edge

In recent years, single-parent captive insurance companies have consistently outperformed commercial market insurers based on their ratings and lines of coverage. This superior performance is attributed to the balance sheet strength, operating performance, and business profiles of captive insurers and their corresponding insureds compared to their commercial counterparts.

Captives can play a positive role and are able to provide a competitive edge to the organizations using them. Here's how and why.

1. Homogeneous Risks

Generally, single-parent captive insureds will have similar risk profiles and diversity across the organization or related third-party coverages. A single-parent captive insures the parent company and its affiliates, so the risks belong to a controlled group of insureds. This homogeneity of risk benefits the captive by establishing a certain level of predictability, which helps maintain consistent rates and an unsurprising loss ratio.

2. Underwriting Profit/Results

Captive insurance companies enjoy greater underwriting profits than commercial insurers for several reasons, primarily because risk management, control, prevention, and mitigation are central to the captive's purpose. Organizations can benefit from their own good experience and transfer that profitability to the captive rather than through premiums in the commercial market. Captives also facilitate transparency within the organization and provide more access to data through the risk management program (pricing, losses, reserving, etc). This allows organizations to act proactively and implement risk mitigation and control protocols almost in real time.

Comparatively, a fully insured commercial market policy may result in delayed information delivery—most commercial insurance arrangements provide reports a quarter after year-end, if any information at all. In a commercially insured program, obtaining information can also be challenging. Many programs require formal requests for information rather than providing automated statements. These requests are often granted quarterly or even annually, in contrast to the online portals or monthly automatic delivery options typically available to clients in a captive insurance arrangement.

3. Return on Investment

A major advantage that organizations with captive insurance companies have over commercial insurers is the opportunity to recapture the investment income that is a core component of premium pricing by the commercial insurers. Some refer to this as the "float" or generating returns through the delayed payment of claims compared to premium payments. The profits, generated savings from commercial premiums, and accrual of reserves accumulate in the captive and can yield returns on those assets through a diligent investment strategy. Most feasibility studies use an expected rate of return to visualize these compounding returns and the additional savings compared to the traditional market. This makes captives an excellent alternative for deploying capital and earning a return on income. Generating returns can be more than basic investing. Companies may determine the best investment is in themselves and, rather than a traditional investment portfolio, look to loan some funds back to the insured for reinvestment purposes. While these transactions must be extremely vetted and require domicile approval, they can be a great way to diversify the asset portfolio of the captive.

4. Competitiveness

Commercial insurers are sometimes unable to understand the true needs of the insureds and are limited in their offerings or premium credits. Captive insurers create competitiveness in the market and can compel commercial insurers to offer better terms and rates. In many instances, commercial insurers are threatened by the captive's ability to take on all the risk and become willing to create quota share arrangements. Captives are a unique and tailored solution for the insured(s) and offer almost total customization ranging from location to policies to policy language. They have the ability to insure unique risks and can fill in coverage gaps where commercial markets are unable to do so.

5. Enterprise Risk Management

A.M. Best defines "enterprise risk management (ERM)" as "establishing a risk-aware culture and using tools to consistently identify and manage, as well as measure risk and risk correlations." An organization that utilizes a captive insurance company is likely to have a stronger ERM system in place compared to its peers. Since an insured with a captive generally retains more of its risk, with a separate subsidiary (the captive) measuring returns, they are typically more motivated to better manage their own risks and prove out the savings and returns. In most cases, the captive is a vital cog in the ERM wheel. This close alignment allows for better results for both insurers and insureds and a lower total cost of risk for the captive.

6. Retention

Related to, but not the same as, the aforementioned point on competitiveness, many rated captive insurance companies have a retention rate of 90 percent or higher. This is, in part, because policyholders are routinely rewarded through dividend payments from the captive that are significantly higher than any seen in the commercial market. These profits can be used in multitude ways to further benefit the captive. For example, policyholders could underwrite additional lines of coverage without the need for additional capital, provide premium holidays on programs, or fund full-time equivalents.

This, combined with the lack of competition, means that captives don't need to shop around for business each year, creating savings in acquisition costs that can, in turn, be funneled into the captive (e.g., in the form of loss control) to further benefit the insureds.

7. Ability To Identify Emerging Risks

A captive's structure and foundation in ERM gives it an added advantage of foreseeing emerging risks. The risk team and, to an extent, the C-Suite of an organization are involved in the captive's management and activities. Having a strong alignment between the parent company, the captive, commercial insurers, the IT team, risk experts, actuaries, and other key players ensures that everyone is on the same page. A captive can make long-term assessments on the future of the commercial market, insured changes (growth, business lines, etc), and captive growth, while also flagging and resolving short-term issues, such as a regulatory changes or contract insurance requirements, quickly. There is no fragmentation of knowledge in a captive setup, and all stakeholders have the same interests. In sum, captives allow organizations to be nimble and react to changing market conditions quicker than commercial market insurers.

Summarizing

The captive insurance industry is expected to continue its growth trend, along with the continued success and positive returns for specific captives and their parent organizations. The US captive market has grown substantially over the past few years, with domiciles proposing updates to existing captive statutes and new domiciles coming into the fray. Further, we're seeing captives being used more frequently for lines of coverage across the risk spectrum, such as cyber and medical stop loss, adding to the list of use cases.

We anticipate that captives will continue to grow in popularity and outperform their commercial counterparts. Captives are a great tool for insureds to create unique, custom-made solutions in partnership with the commercial markets. They facilitate better claims management—their expenses and adjustments—through accurate estimations.

Perhaps most importantly, one of a captive's best attributes is its flexibility and ability to be swift and proactive without the typical red tape or series of middlemen in a commercial insurance relationship.