Why Do Captive Insurance Companies Get Credit Ratings?

To successfully market their insurance products, traditional insurance companies must establish confidence and credibility. Policyholders need assurance that their insurer has the financial strength to pay claims when needed. One key factor in building this confidence is a strong credit rating from an agency such as A.M. Best, Standard & Poor's, Demotech, Fitch, Moody's, or Kroll Bond Rating Agency. While credit ratings are essential for traditional insurers, their necessity is less obvious for most captive insurance companies.

For group captives and risk retention groups, which compete to some extent with traditional insurers, a strong credit rating can be a valuable differentiator in the marketplace. However, for single-parent captives—where the policyholder has direct control over capitalization and premium levels—the need for a credit rating is not as apparent. Despite this, many single-parent captives are seeking ratings, even though the process involves significant costs. So, what motivates captive owners to pursue credit ratings?

1. Strengthening Corporate Governance

One major reason captives undergo the credit rating process is to enhance corporate governance. A rating agency's independent oversight provides a parent company's board with greater confidence in the captive's operations, reinforcing that the entity is functioning as a legitimate insurance company. This external validation can help ensure that sound financial and operational principles are being followed.

In some cases, captives engage in the rating process simply to gain insights into their financial health and receive recommendations on best practices. In these instances, the goal is not necessarily to obtain or publish a rating but rather to leverage the evaluation as an educational tool for the captive's board and management. The rating process should be viewed as a collaborative effort, fostering open communication with the rating agency.

2. Increasing Transparency

Another key reason for obtaining a credit rating is the growing emphasis on transparency. A rating allows captive insurers to benchmark themselves against other rated captives and provides a clearer picture of their financial standing. Additionally, a strong rating can enhance credibility when raising capital, if needed.

3. Reducing Costs

A credit rating can also help captives negotiate lower expenses. Third-party ratings provide reassurance to reinsurers and fronting companies, demonstrating the captive's financial strength and ability to meet obligations. As a result, rated captives may be able to secure lower fronting fees and reinsurance premiums.

The cost of a credit rating varies based on several factors, including the captive's capital size and the complexity of its structure. Despite the financial commitment involved, the benefits of improved governance, increased transparency, and potential cost savings make the process a compelling consideration for many captives.