Captive insurance continues to be a growing trend for mid to large size organizations as it can provide advantages in risk management, insurance savings, wealth transfer and taxes. A captive is an insurance company that provides insurance to and is controlled by its owners. It is designed for you to take control of your insurance destiny. Your costs could be substantially lower because premiums are based on your loss experience and therefore can insulate you from market conditions.
Captives can bring many benefits as alternatives to other risk financing plans. Properly structured, captives can bring the following advantages:
- Reduced cost of risk
- Direct access to the international market of reinsurers, which can be more flexible
- Increased bargaining power
- Centralize retained losses spread throughout members
- Control of data and analytics
- Long term stability
- Cost transparency
Captives can be valuable strategic risk management tools, but they are not the best approach for every business. For some risk profiles, they are not feasible, and could ultimately cost more than traditional insurance. If your business is considering setting up a captive insurer or looking to join an existing, you must first clearly establish the financial/business goals and objectives of the company. Effective communication between senior management, including the CFO, risk manager and business segment leaders is critical. Together, consider the follow aspects of your company:
- Actuarial or data issues, including loss data or exposure information needed for at least 5 years.
- Reinsurance marketplace potential
- Tax and regulatory issues
- Desired captive design
Several parameters can assist you in determining whether a captive is a viable option:
- You must be financially stable and have a good loss history.
- You must be able to demonstrate your ability to pay for claims and secure future losses. Collateral will be required & full disclosure of financial statements.
- You must be able to dedicate considerable attention to the operation of the captive.
Having concluded that a captive may be a good fit, take the following steps to carefully study the appropriateness of a captive insurer for your organization:
- Review relevant background information
- Discuss financial implications of the captive
- Generate projections of expected loss experience
- Estimate operational expenses associated with the captive to determine premium
- Determine appropriate capital levels or margin of risk
- Describe qualitative factors including location, ownership, support or other issues
- Prepare financial statements with balance sheets and income statements for the captive over a five-year period under different scenarios
- Compare the captive with the status quo on both financial and nonfinancial criteria
Consider the following issues when examining captive insurers:
- Align your investment policy to the assumptions used to set premiums. Consider whether to use the time value of money based on the captive’s assets—for example, letters of credit do not generate investment income, so premiums should not be set considering the time value of money.
- Consider state or domicile premium taxes, U.S. federal excise taxes, U.S. income tax and 953(d) election (for foreign insurance companies).
Partner with an insurance broker and captive management company that will help you evaluate your risk, cost and long term strategy before you join or form a captive.
This Coverage Insights is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice. © 2011-2012 Zywave, Inc. All rights reserved.