What is a Captive Insurance Company?
Captive insurance companies are entities formed solely to finance and manage the risk and exposure of a parent company. Traditionally “Captives” have been fully owned subsidiaries of large Fortune 500 companies – also known as “Single Parent Captives”.
In recent decades multiple variations of Captive structures have been developed that allow for greater flexibility in the utilization for companies of different types and sizes. One of the most beneficial forms is what is known as a Group Captive, which allows many firms to participate in a Captive by reducing the financial barrier to entry.
Some of the MOST popular types of Group Captives are known as Member-Owned Group Captives. These are Group Captives that are OWNED and CONTROLLED by their members to only manage the risk of their membership.
Group Captive Basics
A Group Captive is an insurance company created and operated for the sole purpose of insuring the risk of its members and nothing else.
Traditional Insurance relies upon the “Law of Large Numbers” – which means that with the more clients an insurance company insures, the more that insurance company can rely upon statistical averages to project the amount of money they will pay in claims and how much they can expect to make in profits. With the law of large numbers, the BEST performing clients subsidize the claims of the lower performing clients – Basically saying that the Better Performers pay more and the Lower Performers pay less than they would if they were to only cover their own risk. Group Captives target the Above Average Businesses that would benefit from exiting the traditional insurance marketplace.
Read more about lower premiums and return of unused premiums: Captive Benefits.
Here are some additional details:
Management and Costs with Captive Insurance Company
Most Group Captives are managed by a third-party consulting firm. One of the largest consulting firms specializing in Group Captives is Captive Resources out of Chicago, IL. A little over 1/3 of the Group Captive premiums cover program costs such as the issuing of policies, the acquisition of reinsurance, funding loss control training and initiatives, paying broker commissions, and funding the overall operation. The remaining funds are used to fund claim payments and any funds not used for claims payments are then returned to the members in the form of dividends.
Decision Making Board of Directors
Each business that joins a Group Captive is an owner and as such is also a member of the board with one vote. The Board of Directors makes all major decisions for the Group Captive.
Shared RISK and the REINSURANCE Backstop
For a Group Captive to be compliant, the members must share in the risk of their membership pool. Most of this shared risk is financed through reinsurance with a small portion subject to being shared amongst the membership – a typical year does not see a risk share cost in excess of 5-10% of premiums paid. Group Captives are contracted for Reinsurance through major carriers such as AIG, Hartford, Arch, Chubb, etc.
What Does The Policy Look Like?
Each member of a Group Captive is issued an insurance policy just as they would if they had purchased the coverage in the traditional insurance marketplace. The policy is essentially the exact same in form and function from a coverage, claim, and audit perspective; and it is only on the backend where the financing is different. From the outside looking in, the policy will look the same as a non-captive policy.
How To Join A Captive
Purchasing insurance in the traditional insurance marketplace is relatively simple, you get a quote, pay your down payment, sign your forms and you’re on your way. However, joining a Group Captive is a bit more complicated. Businesses applying for approval to join a Group captive must meet higher tolerances in terms of claims experience and risk control, while also having a strong financial background.
How To Exit A Captive
If a member of a Group Captive decides to exit the program it requires a wind-down period. Similar to the additional complexity to joining a Group Captive as compared to the traditional insurance marketplace, there is also additional complexity upon exit. Each policy year is followed by a tail that lasts on average approx. 5-6 years before the coverage year is officially closed and all dividends are distributed. Although it is not common for a member to leave, it does occasionally happen, although most often due to merger and acquisition activity.
What Are The Benefits of Group Captives
The businesses included in a Group Captive are typically better run and equate to a lower risk exposure from an insurance company perspective. An actuarial analysis is performed on each member business using only that member’s individual claims/loss history to ensure an adequate premium is charged for each member and that each member is not charged for the risk associated with any other businesses. Since the members produce a MUCH lower expected amount of risk, the premiums paid into the captive are also proportionately lower. It is not uncommon for a new member to see some up-front premium savings upon entering a Group Captive, however it is very common for members who are active in maintaining a culture of safety to see their premiums to continue be reduced in subsequent years as well.
Dividends From Unused Premiums
Each Group Captive member has approx. 2/3 of their premium put into their own asset account within the Group Captive which is then used to pay claims. The funds in the asset account are invested and all of the unused portion (including reserved claim dollars until the reserve is closed out or the amounts are actually paid). The balance of the asset account is then returned in the form of a dividend – this includes both the unused funds and the investment return on those funds. The timing and amounts of the dividends are up to the discretion of the Group Captive board, but all monies are eventually returned via a dividend.
When taking into account the return of unused premiums on top of the typically already lower upfront premiums paid, businesses that join Group Captives can experience a material reduction in their risk management portfolio.
Greater Control Over Costs
Group Captive members gain direct control over their insurance costs as compared to the traditional insurance marketplace. In the traditional marketplace, the best performing businesses remain challenged by rate increases from the claims experience of the overall insurance marketplace’s and due to the arbitrary and profit motives of individual insurance companies. When compared to a Group Captive where a business that focuses on safety, compliance and reducing claims sees a direct and proportionate impact in both their premiums paid and the dividends received on the back end, for the Better and Best run operations the choice is clear.
Easier To Budget
One of the biggest complaints from businesses when it comes to their insurance and risk management programs is the lack of ability to budget and forecast costs. In the traditional marketplace a business may see cost swings as much as 20-30% in a given year without having had a change to their overall claims experience. This makes insurance premiums one of the most frustrating line items for many businesses to budget for.
In contrast, members involved in Group Captives have better insight into their year-over-year premium changes due to their premiums being determined solely on their own actuarily analyzed experience. With each member being given their own exact premium and getting regular claims reviews and financial updates, they are never surprised by an ensuing year’s premium charge. Each year members know their exact minimum and maximum exposure, and when and how dividends and assessments are to be collected.
Oversight & Transparency
Every member of a Group Captive is also an owner, meaning they have the right to see and know where and how every dollar is spent. And the Group Captive has the responsibility to provide the detail to the member on a regular basis. This transparency includes such things as how claims are paid, management costs, and broker commissions.
Control Your Claims
Members of Group Captives possess
greater control over their claims, both in terms of management and in terms of
payment. Most Group Captives have a requirement
where the individual member must approve claims over a certain amount – many
times as low as $10,000. In the end the
dollars paid out in claims are those of the member and as such the member is
given the strongest voice in the decision-making process.
Other Types of Captives
There are many types of Captives, from Single Parent to Group Captives. To best determine if a Group Captive is the right choice for your business, it is best to know what other types are available.
Typically used by very, very large businesses, Singe Parent captives are owned subsidiaries of their parent that are created and maintained for the sole purpose of managing the risk of the parent company. The financial requirements to start and maintain a Single Parent captive are high and unattainable for most businesses.
A rent-a-captive is a company created by a third-party management firm to then allow companies with traditionally good claims and safety histories to rent/use the rent-a-captive for a charge. Many times rent-a-captives are good alternatives to Single Parent captives for companies that lack or are not willing to utilize the financial resources necessary to create and maintain a Single Parent Captive.
Self Insured Groups
Self-Insured Groups are NOT a form of Captive, they are used to pool businesses together with the goal to reduce the overall cost for the members. The issue with these groups is that they almost always require the members to agree to a joint and several liability agreements. These agreements then require that each member is responsible for a proportion of the group losses, and then if/when other members are unable to pay their obligations then the members are required to pay the share of the losses for other members as well. As compared to a Group Captive, a Self-Insured Group has a greater risk for members when it comes to unpaid claims by other members.
Who Should Join a Group Captive?
Businesses that are financially stable, perform similar operations year-over-year, annual premiums for Workers Compensation, General Liability and Automobile Insurance of $100,000 or more, have a proven track record of safety and compliance, and are financially stable are typically best set for success within a Group Captive.
The quickest way to know if your business should consider a Group Captive can be answered found through the following two questions:
- Are your combined premiums for Workers Compensation, General Liability, and Automobile Insurance $100,000 or more?
- Do your claims for the prior 5 or more years total less than half of your premiums for the same period?
you answered “Yes” to both questions, then a Group Captive may be a good option
for your business and is something you should consider.
How to Join a Group Captive
On top of the normal considerations that go in to purchasing insurance in the traditional marketplace, when looking to join a Group Captive there are a few more things to consider.
- Financial Strength and Leverage – Since the success of a Group Captive depends on each of its members being able to meet their financial obligations, the financial strength and making sure each member is not over-leveraged are a serious consideration.
- Rates & Pricing – Businesses considering a Group Captive should be mindful that rates are determined and set for the specific business through a full actuarial analysis. This means that there is no “quoting” or “bidding” for rates/premiums, but rather an offer is given based on the individual merits and statistical probabilities for loss of the specific business.
- Business Mix – Both the business considering to join a Group Captive and the Group Captive considering the newly applying business must consider whether the business mix of the group will be beneficial for all concerned if the new member were to join. If the Group Captive is Heterogeneous, then its concern is whether or not the new applicant will provide both strength and diversification. And the new applicant needs to be aware of the business mix of the Group Captive to ensure that they understand the mix of business that they may be impacted by from a risk sharing perspective.
- Timing – The application and evaluation process for joining a Group Captive is far more in depth than that of a typical insurance renewal cycle, and as such it is not often recommended to consider a Group Captive in conjunction with a business’s normal insurance renewal process.
The following is a sample timeline a typical applicant can expect when considering and entering a Group Captive.
|ACTION STEP||DURATION|| BY |
|1.||Collect 5 years |
of claims and
|1-2 weeks||Business |
|2.||Prepare a |
|2 days||Insurance |
|3.||Submit to the |
actuarial review and approval
2 weeks –|
|4.||Review captive |
|1-2 days||Done by the |
|5.||Review the |
captive cost and premium
reviewed at this time
|2 hours||Presentation |
by the broker
and make the
|Upon inception of the insurance coverage|
|7.||Post collateral in either cash or a letter of credit||Up to 30 days |
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