Insurance premiums constitute a substantial recurring business cost for most companies. Additionally, because of evolving business environments, companies now require more tailor-made insurance solutions. For these and more reasons, captive insurance companies are necessary.

In this article, we’ll explore the captive insurance pros and cons.

What Is Captive Insurance?

Captive insurance companies are independent subsidiaries that a parent company creates and manages to underwrite its financial risks along with those of its affiliates. There are three types of captive insurance companies:

  • Pure Captives: These companies are owned and managed solely by and for the benefit of the parent company.
  • Group Captives: These captives cater to a group of companies or individuals with similar risks. Examples include Risk Retention Groups and Association Captives.
  • Third Party Captives: These are captives that in addition to underwriting the parent company’s risk also provide cover to third party entities.

Who Needs Captive Insurance?

Large corporations created captives to avoid the high costs of commercial premiums. However, captive insurance is now an option for businesses of all sizes. A company may opt for captive insurance because of:

  • Unique business risks: Some industries experience unique risks for which there are no readily available covers in commercial insurance.
  • Expensive Risks: Other industries include insurance needs for which premiums. But if available, they would be too exorbitant.
  • Excluded Risks: Most general liability covers will exclude certain risks such as employment practice liability or sexual harassment claims. Additional covers are therefore required to address these risks.

8 Essential Advantages of Captive Insurance

The benefits of Captive insurance include:

1. Lower Insurance Costs

Commercial insurance premiums must cover the cost of overheads. So, claims, and profits of the insurance company, they frequently inflate. Captives allow companies to have premiums that reflect their risk of doing business more accurately. Premiums will also not fluctuate due to market rates.

2. Coverage Flexibility

As mentioned above, Captives are often the last resort for certain risks that commercial insurance companies are either unwilling or unable to cover. Additionally, covers can be specifically tailored to suit the company’s needs. This makes this one of the main factors when assessing captive insurance pros and cons.

Captives can tailor make covers because they are not subject to as much regulation as conventional insurance companies.

3. Control of Data

Captives ensure the parent company’s data remains confidential. They also ensure that complete and accurate data is available for successful risk management. This comes as opposed to relying on direct insurers’ information management systems. This data can also help in reinsurance premium negotiation.

4. Tax Minimization

This is one of the main selling points when weighing captive insurance pros and cons. Section 831(b) of the US Internal Revenue Code allows the first $1.2 million of premiums to be exempt from income tax under certain conditions. This exemption constitutes a substantial saving in tax expenditure for the company.

5. Cash Flow

Unlike insurance companies, Captives offer flexible premium payment plans. This increases cash flow for the parent company. Also, the parent company retains the premiums. Therefore, they are available for investment which means a further increase in cash flow.

6. Profitable Reinsurance Business

Captives can offer insurance coverage to third party companies at more attractive rates than direct insurance. This is because of lower operating costs. Small companies in the same industry facing similar business risks are therefore a profitable insurance market for Captives.

7. Control of Essential Services

When using a Captive, the company retains control of all administrative processes including claims, investments, and underwriting. This control allows the creation of effective risk management programs within the company. Overall, it reduces the entire cost of insurance.

8. Group Captive Benefits

When you join a group captive, there are additional benefits to gain. The administrative processes and costs are incurred by a captive management company so you can focus on your core business. There are plenty of networking opportunities with members of the group. Also, as a shareholder, you enjoy underwriting profits and investment dividends.


5 Key Disadvantages of Captive Insurance

Some of the cons of captive insurance include:

  1. Risk retention: The retaining business risks can reduce cost with the right risk management procedures. But it can also be an expensive affair. Unexpected claims can put a strain on company resources especially if they exceed the loss reserves. This risk especially applies to risks that could result in extreme claims such as professional practice liability. Small businesses or professionals weighing captive insurance pros and cons should, therefore, assess their capacity to bear such losses.
  2. Capitalization costs: Setting up a captive involves various administrative, legal and other costs. Internal resources will be utilized to oversee the setup, taking away resources from the core business. Reserves also need to be established to cover the estimated loss. These costs can cause a short-term strain on the company’s cash flow.
  3. Fronting costs: In some jurisdictions, a fronting carrier is required to issue certain policies. This carrier will charge additional fees, further increasing the cost of insurance.
  4. Captive management costs: Some jurisdictions require the use of an approved captive management company to get the appropriate licenses and registration for operation. You will also need auditors, risk management experts, accountants and other professionals to maintain the Captive. These cumulative costs could exceed those of regular insurance premiums in some instances.
  5. Control of data: Outsourcing your administrative functions to a captive management company may mean the loss of control of data. This loss impacts the effectiveness of your risk management program and could expose your company info to external elements.

To Sum Them Up

From the captive insurance pros and cons above, it is clear that there are multiple benefits that you can gain by setting up or joining a Captive. This Alternative Risk Transfer vehicle can significantly reduce insurance costs while providing new revenue and investment streams. Adequate feasibility studies should, however, be carried out to determine the viability of setting up a Captive insurance company for a particular company or industry.

Sometimes, commercial insurance covers outweigh the captive insurance pros and cons because of risk transfer and management benefits. It is important to seek the services of tax, legal, risk management, and investment professionals to enjoy the full benefits of captive insurance.

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