In today’s volatile business environment, the concept of gaining control of any aspect of your organization can be appealing. Company owners and leaders often feel that this greater control can reduce headaches inflicted by outside forces. With that in mind, property & casualty captives are an option that many businesses should consider (for workers’ compensation, for instance), but they first need to understand that captives are not for everyone.
A captive is an insurance company created and wholly owned by one or more of its insureds. The purpose of a captive is to insure the risks of its owners. In other words, captives are a form of self-insurance for businesses that are seeking greater control over how they spend their insurance dollars. (It’s important to note here that greater control doesn’t automatically mean lower premiums). However, if the members of a property & casualty captive don’t have as many losses as anticipated they will receive return premium in the form of a dividend. In a standard insurance program no monies would be returned and the insurance company would retain this premium as profit.
Created in the late 1950s for companies in “risky industries” as a way to control their financial exposures (such as mining), captives are still a fairly uncommon approach to manage property & casualty insurance risk and cost. Even so, the number of property & casualty captives has jumped over the last few years with nearly 7,000 currently in operation.1
Captive members can get coverage for general liability, workers’ compensation and employer’s liability, as well as auto liability and physical damage. Premiums are determined by actuarial analysis of exposures and losses.
In many respects, getting into a captive is an aspirational goal for a company, like joining an exclusive country club. Having the right profile to join a captive is a sign that a business is managing its risk well and has reached a certain status. For a captive’s member businesses, the primary attraction is the opportunity to pay less for coverage. Members receive the underwriting profits of the captive if and when premiums exceed claims; essentially they earn a dividend if the captive performs well.
Companies that join captives tend to have overall rates that are lower than their competition’s rates, so membership becomes a competitive advantage. Captive members are shielded from the ebb and flow of the marketplace and they won’t feel the effects of a hard market (in which rates are steadily rising) quite as readily as non-members. Additionally, captive members value loss control, and consequently they share information and best practices to help each other—another competitive advantage.
So, should you consider a property & casualty captive for your organization?
Maybe. But there are several factors to consider. While the road to a captive often starts with a desire to gain better control of how insurance dollars are spent, the most important of these factors is having an excellent loss history and safety control. Companies that typically have fewer claims than others in their industry are often a good fit for a captive.
In order to be a good candidate for a captive, a company must typically have at least a total general liability, automobile liability and physical damage and workers’ compensation annual premium of $150,000. This amount varies from captive to captive. Before inviting a business to join a captive, the captive manager will examine the candidate’s financials to ensure the ability to pay premiums.
If the company’s profile fits, the broker will put together a submission to appropriate captives that it aligns with. This submission will include five years of loss runs for worker’s compensation, general liability and automobile lines, as well as the company’s financials over that time and historical premiums and exposures.
Typically, a property & casualty broker that has experience with captives handles this process for a client, because the submission can get quite complex. In some ways, the process is like the recruitment of a college athlete – the captive is evaluating the company, but the company is also evaluating the captive. The captive wants to be sure that it is bringing in a member that will help the other members. But the company must make sure the captive is the right fit for its purposes, and that it’s “worthy” of its superior risk management history.
A captive can be a significant advantage for a business as long as it has the necessary risk tolerance. While we’ve laid out significant advantages for membership, it’s important to remember that a company is actually placing a bet on itself when it joins a captive. It’s a significant advantage to be in position to do so, but like anyone who gambles, it’s important to never lose sight of the risk.
1 Business Insurance, “World’s 10 Largest Captive Domiciles”
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