Considering a captive insurance structure for your company? Everywhere you turn are articles telling you why you SHOULD form a captive insurance company. There are a few things you need to know – including reasons why this model might not actually be the in the best interests of your business.
What is Captive Insurance?
Captive insurance is typically defined as insurance that is wholly owned and controlled by its insureds. The main purpose of the captive insurance structure is to insure the risks of its owners, and its insureds benefit from the captive insurer’s underwriting profits. I have written and spoken extensively on why a business owner may want to consider a captive.
Some of the reasons you might want to reconsider your idea to implement a captive insurance company for your company can include the following:
Reason 1. You Lack Insurance Expertise (and Don’t Care to Learn)
If you wants to adopt a captive insurance company for your business, you will need to develop a rudimentary understanding of some the relevant expertise for the fundamental insurance disciplines (claims reserves, corporate taxation, actuarial price making, etc). Usually, lack of insurance expertise is not an impediment to forming a captive but the willingness to learn should be. Business owners need to throw away their preconceived notions about how insurance works.
Captive management companies step in to fill this knowledge gap, but ideally, the business owner should have the desire to learn these concepts. More importantly, interest from company leadership about how captive insurance works is necessary. Ultimately, if you are not willing to put in the time to learn what you need to know about the insurance industry then captive insurance probably is not the best choice for your business.
Reason 2. You Suffer From Lack of Vision
A company looking to create a captive insurance company also needs to have a clearly defined business objective for forming the captive (and no, an IRS tax deduction is NOT a good enough reason). Having a clear business purpose and goal in mind sets the captive insurance company up for success
Are you looking to save money on premiums? How is your existing enterprise risk covered (i.e. business interruptions from COVID)? What are the specific business problems that you as a company are looking to address and manage through a captive insurance model? If you cannot answer that question the captive model probably is not right for your company.
Reason 3. You Have Long Term Commitment Issues
If you are not sure where you see yourself and your business in the next few years, it probably isn’t worth it to set up a captive insurance model. The design and implementation of a compliant, solid captive insurance company requires upfront work and investment. Your captive insurance managers will submit the business plan, actuarial and feasibility studies to the regulating bodies in the jurisdiction but if the captive owner can’t provide the long-term vision or business objectives the plan will be weak.
Also, keep in mind, a change in the parent company’s business plan or a merger might result in the captive insurer being placed in a run-off mode. Expenses of a captive in run-off produce no current economic benefit.
It may also not be worth the money if you do not have a long-term vision. At a minimum, you should be prepared to commit 5 years to setting up and managing a captive insurance structure in your company to justify the energy spent making it happen.
Reason 4. No Real Desire to Do Corporate Governance
Once you set up a captive insurance company you to need to be committed to running it like a business. You can’t just set it up and walk away – you have to have policies and procedures in place. Having a framework helps your company avoid making short-term and long-term mistakes when utilizing a captive insurance company.
Having a strong governance structure is what keeps you out of trouble. There is an increased administrative burden associated with captive insurance that interested companies have to manage. Captive managers are ultimately responsible for such items as claim administration, loss control, accounting, and underwriting.
Managing these items and services requires additional time, money, personnel, and actuarial partner commitment. These costs should be greatly reduced by contracting out administration to captive management companies. However, management fees and expenses may reduce the premium savings expected in comparison to conventional insurance solutions. The costs to run a professionally designed and implemented captive should be paid for from the company’s insurance premium savings in the traditional market.
Reason 5. You Cannot (or Will Not) Adequately Fund Your Captive Insurance Company
During the initial stages of captive formation, your company needs to have enough capital on hand to manage the initial set-up costs and the capitalization required by the domicile’s regulatory body. As stated above, your captive insurance company expenses should be paid for from the savings on your traditional insurance program.
You also need to remember that, even after the initial startup, it takes money to run the captive insurance company. The amount of premiums paid into the captive need to be correct – especially at the outset when you need a high level of confidence that there will be enough money in the captive when or if there is a claim.
You cannot cheap out on these things without sacrificing the backbone of the company. If you are considering cutting corners you should probably just forgo the captive insurance company for your business.
Reason 6. You’re Not Sure How to Delegate
A high degree of delegation and partnership is required when a captive manager is engaged. This requires a commitment in the form of management time, but if your company already employs a risk management specialist, this time commitment should be within the normal arena of such a manager’s duties.
Reason 7. You Cannot Weather the Market Volatility
In many cases, the reinsurance market reacts more quickly than the primary insurance market when the business claims, or even a global catastrophe occurs. For instance, because the reinsurance market tends to be experience rated (premiums closely reflect the loss history of the insured), a reinsured risk of a captive insurer might face premium increases sooner than a commercially insured risk.
It is common knowledge that what makes sense for one organization may not work for another – and the appropriateness of captive insurance is no different. Ultimately, the best way to determine whether captive insurance is appropriate for you is to leverage industry experts, including consultants, actuaries, or attorneys. These experts can provide sophisticated risk management advice to help you decide what direction to take your company in.