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Captive insurance programs have been popular among business’ largest corporations since they were first created in the 1950s. As we enter 2020, however, captives are enjoying a resurgence as a growing solution for businesses of all sizes trying to think outside the box.

Captives allow businesses to maintain direct control of their insurance programs, creating a fully personalized experience with its own unique challenges and opportunities for reward.

Even though captive insurance programs can help businesses navigate the challenges of employee benefits management, reduce costs, and build a more useful experience for employees, there’s a major lack of understanding about what they are and how they work.

Moving forward, we will:

  • Define captive insurance for beginners
  • Explain the difference between a captive and traditional commercial insurance
  • Review the main pros and cons of captive insurance
  • Provide guidelines to help determine if a captive insurance program might be right for your business

What is Captive Insurance?

A “captive” insurance company is an organization that exists only to meet the specific insurance needs of its member/owners. That means the business or businesses insured by the captive are its sole and total owners.

Captive insurance can help a business fulfill all its insurance needs, from employee benefits and general business insurance to worker’s compensation, product liability, auto insurance, and so on. That’s why captives have historically been popular with Fortune 500 companies and major corporations: they provide complete independence and allow businesses to circumvent many of the inefficiencies of the commercial insurance market.

When you have an insurance company whose only focus is the support of your business, you can achieve some pretty impressive stuff.

  • You can get your employees the benefits plans they need while controlling expense for them and the business
  • You can scale your coverage to your exact needs to minimize overspend
  • You can eliminate the offerings you don’t need while finding the best version of what you do need

In order to gain that independence, however, you must assume the possibility of greater financial risk. When you make the switch to captive insurance, you’re gambling with your own money, and no longer have your insurance provider to fall back on because you are now the provider.

Different Types of Captive Insurance

It’s important to know that there’s more than one kind of captive. Let’s take just a minute to define the main types of captive insurance programs out there.

  • Single-Parent or Pure Captive: A captive that is owned by and works exclusively for its parent company and its subsidiaries (as for a corporation)
  • Group or Association Captive: A captive insurance program created by multiple small or medium-sized companies pooling their resources and risk to access the advantages of a captive
  • Rental Captive: An existing, independent captive operated by a business entity that other organizations can opt into temporarily
  • Protected Cell Captive: A captive in which each organization’s assets and liabilities are kept separate, allowing access into the captive but minimizing the biggest possible financial gains and losses
  • Agency Captive: A captive managed by a specific agent, who is empowered to reinsure the company by contracting with traditional carriers based on their assessments

How is Captive Insurance Different from Commercial Insurance?

Now that we’ve defined “captive,” let’s explore how captive insurance is different from many of the other models you might be familiar with.

What’s the Difference Between Captive Insurance and Being Fully Insured?

In short, a captive is the complete opposite of being fully insured.

When you’re fully insured, you pay a set monthly fee to your insurance company and they assume all financial risk. Being fully insured is most useful if you don’t have the capital available to cover anticipatable risks.

A captive is only possible if your business has more than enough capital available to cover anticipatable risks or if you partner with other organizations to pool resources.

What’s the Difference Between Captive Insurance and Being Self Insured?

Captive insurance is a form of self-insurance, but the two terms are not interchangeable.

A self-insured business maintains a specific savings account for unforeseen insurance costs and uses that “rainy day fund” to cover losses or fill gaps in coverage. However, that coverage is still purchased through the traditional insurance marketplace.

A captive is far more complex than basic self-insurance because it involves an organization creating its own insurance entity, not simply socking away money to pay for insurance-related costs.

What’s the Difference Between Captive Insurance and Mutual Insurance?

In a mutual insurance company, the provider is owned by its policyholders, acts on their collective best interests, and distributes any profit through either lower rates or payouts.

That sounds pretty similar to captive at first, but there’s one key difference: a mutual company, although owned by its policyholders financially, acts as an independent entity. Policyholders buy in and then trust the provider to do good by them.

In a captive, the insurance company is part and parcel of the greater organization which it serves and is steered according to identified business needs.

Advantages of Captive Insurance

We’ve laid out a lot of information about what captive insurance programs are, how they work, and how they can transform an organization’s approach and identity. Let’s pause to reflect on the positive potential of captives.

A captive insurance program can help you:

  • Reduce insurance costs – When you own the insurance company, there’s no mark-up for services and no need to purchase any coverage you don’t want or need. Captives offer businesses the best and most granular control over their costs compared to any other insurance model.
  • Reward yourself for good planning – Captives provide the most benefit to businesses with great self-knowledge. If you understand your assets, risks, needs, and scale well, you can create a captive that protects you with minimal overspend in a bad year and generates difference-making profit in a good year.
  • Create ideal employee benefit packages – Each workforce has its own specific, identifiable healthcare and employee benefit needs. Unfortunately, even with a great broker, it’s tough to create bespoke coverage that meets everybody’s needs and saves everybody money. A captive allows businesses to get creative and find new ways to get their employees exactly what they need without having to spend a dime on things they don’t.
  • Insure outside-the-box risks – Sometimes an organization needs to take a big risk and gamble on itself to take the next step. Finding insurance to protect investors and keep the core of the business whole should one of those major strategic gambles fail is more difficult than ever on the open market. If you have a captive insurance program, however, you can create whatever coverage you need and avoid needing to “sell” a carrier on your business plan.
  • Specific tax benefits – There’s a misconception that all the tax benefits of captive programs have been eliminated over the last few years, but that’s actually not true. First of all, all premiums an organization pays to its own captives are tax deductible. Furthermore, in down years, he captive’s status as an insurance company can earn its parent organization loss reserve deductions.

Disadvantages of Captive Insurance

Of course, as we’ve seen, the captive program approach isn’t right for every business. Let’s pause briefly and reinforce the main reasons and organization would not want to create a captive.

Unfortunately, with a captive insurance program, you:

  • Assume increased risk – When you form a captive program, you are your own support system. There’s nobody else paying into the pool of funds that’s used to bail you out in a pure captive, and even in a group captive, if multiple partners have bad years, it can lead to major financial complications. If your business is risk-averse by nature, a captive might not be right for you.
  • Take on up-front expense – Establishing a captive is a time-consuming process that requires creating an insurance company from scratch.That means, as you’re planning and building your program, you’ll need to take on more hires, acquire new licenses, and bring in some consultants who are captive experts. At the same time, you need to allocate capital to underwrite your plans.
  • Create new management responsibilities – People sometimes misunderstand that a captive can be managed by a human resources department’s employee benefit expert. That’s actually not true, as the captive is a full-time, constantly operational insurance company. That means either bringing in new managers to operate the division or creating new responsibilities for other members of your core team.
  • Risk taking a step back –It’s possible that, in its initial years, your captive might not do as good of a job as a traditional provider. If you’re not comfortable taking one step back to take two steps forward, a captive probably doesn’t fit your leadership style.
  • Don’t get the tax benefits you would have in the past – While captives still deliver some tax perks, they’re definitely not the shelter and deduction powerhouses they used to be. With that said, if your main motivation for creating a captive is tax protection, you’re likely not a good candidate for a captive program in the first place.

How to Know if Captive Insurance is Right for You

In general, captive insurance is best for businesses that are:

  • Large and stable (or medium-sized and stable, backed by a group of similarly stable partners)
  • Comfortable taking risks with the potential for high reward
  • Thinking and operating in an open-ended, creative way
  • Recruiting a diverse workforce with varied medical needs and preferences
  • Dissatisfied with traditional corporate and business insurance
  • Confident in their ability to improve over time

On the other hand, businesses should keep away from captives if they are:

  • Small or in an early developmental stage
  • Risk averse or unable to raise significant capital
  • Relying exclusively on outside companies and contractors to identify and manage their insurance needs
  • Completely satisfied with the pricing and coverage they get through traditional insurers
  • Unwilling to take one step back in the short term in order to take many steps forward in the long term

Key Takeaways

Captive insurance programs are unique, complex, and create brand new challenges for the businesses who decide to leverage them.

At the same time, however, captives remain underappreciated as ways to meet all of your business’ total insurance needs while controlling costs and connecting with your ideal coverage.

There’s no “right answer” when it comes to whether captive insurance programs are effective or not; the approach’s potential for success is directly tied to an organization’s desire to think and work beyond the limitations of the traditional marketplace and commitment to getting things right.

If you’re wondering if a captive program could benefit your organization, remember:

  • Captive insurance companies support only the organizations that own them
    • A “pure” captive involves just one company or corporation
    • A “group” or “association” captive involves a group of businesses banding together to share risk and support one another
  • Starting a captive insurance program is basically the opposite of being fully insured – you assume all risk
  • Captives can help organizations build bespoke insurance plans, both for business needs and employee benefits
  • Captives aren’t for small or risk-averse businesses
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