In today’s increasingly complex and unpredictable business environment, companies are facing heightened risks that challenge traditional insurance models. As a result, many businesses are turning to captive insurance as a solution. Captive insurance, once considered a niche tool for large corporations, is gaining popularity among businesses seeking more control over their risk management strategies.
What Is a Captive?
A captive is an insurance option that provides insurance to, and is controlled by, its owners. Captives allow the insured entities to benefit from better-than-expected loss experience and potentially reduce the total cost of risk. They are unique, are formed and licensed by many domiciles and are regulated either onshore or offshore.
There are three main types of captives a business could participate in:
- Group Captive: Owned and controlled by a group of businesses, these companies come together to form a group captive to insure their collective risks. By pooling their resources, they can save money, share the costs of insurance and have more control over their insurance programs. Group captives are especially useful for companies that might not have enough resources to create their own single parent captive.
- Single Parent Captive: Owned and controlled by one business, the parent company uses the single parent captive to insure its own risks. By doing so, a company can save money, have more control over its insurance and customize coverage to better suit its needs.
- Agency Captive: Created and owned by an insurance agency or brokerage, the agency captive is set up to provide insurance coverage for the clients of the agency. The agency collects premiums from its clients and uses the captive to insure their risks. This allows the agency to offer customized insurance solutions, save money and have more control over the insurance process. Clients benefit from the agency’s expertise and the tailored coverage.
Any insured who purchases captive insurance must be willing and able to invest its own resources. The insured in a captive insurance company not only has ownership and control of the company but also benefits from its profitability.
Captives Are Rising in Popularity
The growing popularity of captive insurance can be attributed to several factors, mainly, economic conditions such as inflation and a shift in interest rates from historic lows, along with legal system abuse. As a result, the costs associated with claims has steadily increased in recent years. Captive insurance offers businesses greater control over their risk exposure. By setting aside their own capital to cover potential claims, companies can mitigate the impact of inflation and legal system abuse on their insurance costs.
The recent shift in interest rates has also played a role in the appeal of captives. “Risk managers and CFOs are now looking into alternative approaches, which are outside of the traditional broad-based industry solutions focused on pricing adequacy. A creative way to do this is with a group or single parent captive,” explains Matt Moore, head of captives at The Hartford.
Moore explains that based on the economic inflation and shifting interest rates, insureds are searching for new ways to combat increasing costs. “Now, interest rates are off the historic lows we saw in years past, where you had risk free rates close to zero. While there is still a ten-year treasury sitting just under 4%, if you look at that compared to four or five years ago it's a big difference in a business’s ability to earn investment income.”
As interest rates fluctuate, businesses can potentially reduce their costs and benefit from the investment income generated within the captive.
Benefits of Creating a Captive
As businesses navigate an increasingly volatile risk landscape, the benefits of captive insurance have become more pronounced. Captives offer long-term pricing consistency and control, providing businesses with greater predictability in their insurance costs.
“For example, let’s say your business has warehouse and distribution exposures. You’re doing everything right. You have telematics, cameras, everything needed to get the best drivers. You are making the right investments in yourself. At the end of the day, there are still going to be pricing pressures even though you’re a clean risk,” says Moore.
“Now let's think about taking some of that risk on yourself. If you cede a portion of your insurance premium to a captive and only have minor losses, then you’ve outperformed your expected loss. That's funding that can be used and eventually returned, and reinvested, back into the business. The way you're thinking about the economics becomes less transactional and more about whether you can control your risk and have better performance.”
Additionally, captives allow for enhanced claims management, enabling companies to tailor their claims processes and settle disputes more efficiently. This, in turn, lowers financial risks by reducing the frequency and severity of losses. Businesses are often more proactive in identifying and mitigating risks when they have direct financial interest in the outcome.
Moore also shares the educational benefits of a group captive. In a group environment, companies can learn from each other how to strengthen their business. “Control and consistency are huge, but in a group environment the ability to share best practices and learn from each other to improve is fantastic. You've created your own little ecosystem for superior risk management and an accountability system when you're sharing risk with each other. There is an element of what's good for you is good for the group.”
Is a Captive Right for You?
As with any insurance option, there are important risks to consider before deciding if a captive makes sense for your business, including:
1. Financial Requirements
Captives typically have a gross written premium to qualify. A company that wants to participate in a captive must be able to provide sufficient funds to cover potential claims and meet the regulatory requirements.
“Someone who is looking for a long-term partnership to lower their eventual total cost or risk would benefit from a captive,” says Moore.
2. Regulatory Requirements
Captives must comply with the regulations of the jurisdiction where they are created. This can include ongoing reporting and regulatory obligations that can be complex and time consuming.
It’s important to have a captive manager that is well versed in the nuances of the domicile. “The captive manger handles the relationships with the monetary authorities, the domicile and the regulators to make sure that they're compliant. It’s important to do your due diligence and make sure the captive manger has the right expertise,” says Moore.
3. Operational Complexity
Running a captive involves a variety of different tasks such as underwriting, claims management, accounting and regulatory compliance. You must have the expertise and resources to perform these tasks successfully. When operating a captive, it’s crucial to have the resources within your organization that can utilize the appropriate risk management structure and staffing.
4. Risk Concentration
If a captive experiences an unexpected loss, that can impact the financial stability of a company. Your business should have enough assets available to pay claims as they arise. If you don’t feel confident that your company can absorb the fluctuation because you do not have the capital to do so, then the traditional insurance marketplace may be a better option for you.
If your company has a strong financial capacity and the right support systems in place, a captive could be a good option to explore. “It’s important to consider who makes a good captive candidate,” says Moore. “Someone who is extremely invested in safety, risk management and claims management. It should be a business with a commitment to culture and a long-term view on the economics of insurance buying. It is rare to save money in the short term, but a captive can create pricing stability and a lower total cost of risk for the long-term.”
To learn more about captive insurance programs, visit The Hartford’s Captives Program Overview.
