The traditional business insurance relationship is a contract between a policyholder and an insurance company. The typical functions of an insurance agency include claims management, underwriting, risk control, auditing, finance, policy issuance and reinsurance. The policyholder pays an annual premium and in return, secures a promise from the insurance company to pay claims. However, over time, some interesting alternatives to this arrangement have emerged that can offer some key advantages to the right insured.
Business Captives were developed to help business owners take a more significant role in their risk management while providing opportunities to grow capital through the investment of premium dollars. The purpose of a Captive program is to take advantage of any underwriting profits after all claims have been paid. Around every 1 in 4 years, a policyholder will have a large claim that may be more costly than the annual premium of that specific policy, but statistically, the benefit of this traditional arrangement lies with the insurance company.
For insurance, a loss ratio is the ratio of total losses incurred in claims plus adjustment expenses divided by the total premiums earned. To better understand the significance of a Captive, let’s hypothetically look at a company with a strong safety culture and a five-year loss ratio around 30%.
In a traditional insurance relationship, this company could be paying $400,000 in annual liability premiums, comprised of an $80,000 auto policy, a $120,000 general liability policy, plus $200,000 for workers compensation. In this example, over the course of five years, this company actually incurred $615,000 in claims. The $1,385,000 of unused premiums they paid went to funding the operations of the insurance company and to pay other claims.
In a Captive environment, business owners have direct access to these funds which they are able to invest in other opportunities. Captives operate like an insurance company, but are really just a group of policyholders that are willing to pool their premium dollars together to secure these underwriting profits. While the Captive is wholly owned and controlled by its policyholders for the purpose of insuring their risks, the company functions are outsourced and managed through a Captive consulting company. The Captive consulting company will solicit services for insurance company operations at the direction of the Captive’s Board of Directors.
With all of these elements working together, the goal of the Captive is to provide its members with a long-term solution for financing risk. Each Captive program will have various components depending on the risk profile and maturity of the individual Captive.
As an owner/member of the Business Captive there are some key advantages. Your premiums, including impact of workers compensation experience modifications, are insulated from the changes in market conditions. As a shareholder, there are dividends made available in addition to significant opportunities for investment income. The object of the group is to secure as much of the underwriting profits available for its members after claims have been paid.
When exploring Business Captives, consider the shared risk factor and collateral requirements. In a Captive, the “shared risk factor” is the fact that each member pays an additional portion of their premium to pay for other members losses.
When evaluating different Captive structures, it is important to understand the impact of the group’s shared risk factor and historic loss performance of the members.
If the impact of the group’s performance bears significant weight on your individual returns, make sure members are on track for a long term, strong loss ratio. Member selection is a critical component to conducting a profitable Business Captive.
When joining a Captive you will be required to post collateral either with cash or a letter of credit to make sure you are in the position to fund your losses. After several years of favorable experience in a Business Captive, your premium dollars will create a surplus reserved to fund losses so collateral will no longer be necessary.
When determining whether your company would benefit from a Business Captive, take into consideration several factors of a common member profile: Your business should have over $300,000 in workers compensation, auto and general liability premiums annually, a five-year loss ratio stronger than 40%, and be financially capable of meeting the collateral requirements for entry.
As a quick recap, a Business Captive is a group of individual insureds that come together to finance their own risk and outsource insurance company functions for the sole benefit of members. Understanding the risks and rewards of Business Captives will improve an insured’s ability to control their insurance investment and potentially secure returns on their annual premium dollars.
Business Captives were developed to help business owners take a more significant role in their risk management while providing opportunities to grow capital through the investment of premium dollars.
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