Well-established businesses with consistently low claim volumes can implement greater internal controls, create efficiencies and realize financial benefits with an alternative risk management solution, such as a captive insurance company (captive).
With a captive, your business creates an insurance company that it owns, and from which it remains a legally separate entity, to handle designated insurance underwriting needs for the parent company and any subsidiaries. Rather than making premium payments to a third-party insurance provider, you instead pay the policy premiums to the captive, which is typically run by dedicated plan and account administrators to address the necessary regulatory and compliance requirements. The capital accumulated then is used to pay out claims as needed.
For companies with the appropriate size, structure and risk appetite, a captive can add a level of predictability to what may be an otherwise unpredictable area for businesses. Additionally, in years when premiums exceed claims, the profit generated opens a variety of wealth building options. You also maintain control over legal representation and claims management.
Prepare for a thorough review of your corporate structure and be ready to provide documentation and data detailing the various controls your business deploys to mitigate risk. To begin this process, you may work with an insurance broker who specializes in captives to ensure proper due diligence is completed.
During due diligence, an insurance underwriter will closely examine the previous five to 10 years of claims for your business to make informed risk projections. Companies with a sustained period of few or no insurance claims will be in the best position to benefit.
It is likely that corporate leadership also will be closely evaluated. Recent or planned changes at the top of the house are of particular interest because new management styles, expectations or shifts in corporate culture could potentially impact previous trends across the business.
Additional internal reviews may cover everything from hiring practices, orientation programs and employee safety to cybersecurity and the protocols designed to protect your company’s finances and customer data.
Once viability has been determined, your company’s size, coverage needs and premium costs will influence the captive structure that is best to pursue. A pair of the more common approaches are group captives and single-parent captives. Regardless of the size or structure, the benefit and goal remain the same — retaining underwriting profit for your high-performing business.
Group captives tend to be a good fit for small and midsize entities. In this case, your business will form a company with other strong businesses to cover a specific insurance line or lines. For example, general liability, workers’ compensation and automobile insurance may be covered under a group captive, and then each company would pursue traditional coverage for the other lines that their businesses require.
For large corporations with affiliates, a single-parent captive is created to insure one parent corporation and its various entities. With a single-parent captive strategy, you are afforded greater flexibility in what comprises a policy — from core coverages to specialty lines — based on what best fits the needs of your business.
Of the capital that is annually dedicated to the captive, you will have a portion that is a fixed cost related to operating the insurance company that has been formed. The remainder of the capital is used for paying claims. In a year when you have relatively few claims, the excess cash becomes an asset that, when properly managed, can support other areas of your business. Consider working with one of our trusted financial advisors to maximize return on the profit your business retains based on your risk appetite.
If you are thinking about starting a captive insurance company, be sure to consult your attorney regarding legal considerations and your tax advisor to understand any tax regulations or implications.
