The Benefits of Captive Insurance Companies

The following comes to us from Risk Management Advisors, a national firm specializing in the design, implementation, and management of captive insurance companies, and is republished with permission. For further inquiries, reach out to Martin Eveleigh at [email protected] or Max Jong at [email protected].

Business owners often find themselves paying significantly more in insurance premiums than they receive in claim payouts. This is a common scenario for the vast majority of even the most successful organizations. Traditional insurance companies aim to generate profits and satisfy investors and board members. To achieve this, their revenue model relies on collecting adequate premiums and minimizing payouts.

What Is a Captive Insurance Company?

For the purpose of writing property and casualty insurance for a select group of insureds, captive insurance companies are C-Corporations or legal entities taxed as such. Starting a captive insurance company allows for reduced commissions, lower state taxes, control over investments, and setting of reserves. This control over insurance provides the following long-term, big-picture benefits.

1. Handling Your Own Claims

Workers compensation typically operates with a 50 percent margin under traditional insurance models, meaning that these companies expect to pay $500,000 on $1 million in premiums. If end-of-year claims total $800,000, traditional insurers can increase reserves to capture the additional $300,000. Even if only $100,000 has been paid out, the insurer can add that amount to premiums for the next 3 years.

In contrast, a captive insurance company does not face the operating expenses, overhead, or profit requirements of traditional insurers. Moreover, it is not burdened by the need to maintain high rates to cover losses from high-risk insureds. A captive's primary focus is on its own company, with the goal of reducing insurance costs through enhanced risk management.

2. Paying Yourself

Setting reserves and managing claims independently enables a captive insurance company to accumulate funds at a significantly higher rate. Payments made to a captive insurer can be retained within reserves and invested to generate substantial long-term returns.

For example, consider a scenario with $500,000 in standard claims. If $1 million is paid to the captive insurance company and $100,000 in claims are incurred, the captive insurer retains $900,000. This amount remains within the captive's account, generating investment earnings annually.

3. Customizing Enterprise Risk Management

Traditional insurance companies are often unable to offer plans tailored to the unique needs of individual businesses. Their broad approach prevents them from meeting specific requirements and providing customized premiums and payouts. Even industry-specific insurers face challenges, as they must cater to a wide range of operations within the same sector.

In contrast, a captive insurance company is fully specialized and bespoke, designed to manage the specific risks of one business. This allows for every detail of the organization to be factored into the terms, resulting in the most optimal premiums and payouts.

4. Leveraging Reinsurance Pricing

Standard commercial insurance companies typically engage in reinsurance, a practice where they purchase their own insurance after assuming the risk of their clients. This strategy helps mitigate the potential financial impact of claims that may arise on behalf of their insureds.

An invaluable aspect of reinsurance is its availability at wholesale prices. As a captive insurance company, you can capitalize on this wholesale reinsurance market, securing coverage at favorable rates. With direct access to reinsurance, you can enjoy significant cost savings without the added fees associated with agents, brokers, and insurer profit markup.

However, the advantages of reinsurance extend beyond favorable pricing. A company, operating through its captive, gains full control over the selection of reinsurance partners, enhancing flexibility and strategic decision-making.

The contents of this article are for general informational purposes only and Risk Management Advisors makes no representation or warranty of any kind, express or implied, regarding the accuracy or completeness of any information contained herein. Any recommendations contained herein are intended to provide insight based on currently available information for consideration and should be vetted against applicable legal and business needs before application to a specific client.