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The Best Candidates for Captives

March 31, 2023

Why use a captive?

Captive insurance companies, which are established to finance the risk of a parent group or groups and sometimes these groups’ customers, can provide advantages in risk management, insurance savings, wealth transfer and taxes. While there has been a rise in the use of captives and captives remain an attractive strategy for many, not all companies are good candidates.

Who are the best candidates for a captive?

Captives have traditionally been used by major corporations. However, the last decade has seen a rise in small- to medium-sized and nonprofit organizations turning to these alternative risk financing solutions.

Before diving too deep into the captive formation process, it’s vital to consider several parameters to determine whether a captive is a viable option.

Financial Stability

While some captives require expenses stay below a certain percentage, it boils down to profitability, capital to invest in themselves, and there is no competing need for that capital. Captive regulators want businesses to be able to demonstrate your ability to pay for claims and secure against future losses.

Good Loss History and Low Claims Frequency

Your loss history and low claims frequency will determine long-term viability of a captive. That doesn’t mean a company with a history of claims can’t pursue a captive solution. If your claims history shows controllable claims, plus a focus on loss control and safety to lower the impact of future claims, your company is a viable candidate for a captive solution. Essentially, the more you can reduce your claims frequency, the more profit in the captive.

High Insurance Premiums

If your insurance premiums don’t align with your loss experience due to market trends, you may find a captive, which is based on loss history instead of market rates, is a good solution. For example, any company spending over $150,000 on general liability, workers’ compensation and auto should explore the viability of a group captive. Additionally, any company with a total premium spend of over $500,000 on all lines should explore a single-parent or cell captive options.

High Risk Tolerance

Companies must be comfortable retaining risk before setting up a captive to finance that risk. This means understanding the benefits and considerations of retaining risk independent of a captive. If an organization feels it is in its best interest to retain risk to control costs, then a captive is one potential solution to finance that retained risk. Other solutions might be a high deductible program or going fully self-insured.

Additionally, companies looking to reduce reliance on commercial insurance, have leadership in need of asset protection or have unique risks may be ideal candidates for a captive.

Once you have determined if your company meets these parameters, you can get together with senior management, the CFO, risk managers and business unit, consider your organization’s:

  • Background and financial goals
  • Actuarial or data issues, including loss data or exposure information needed, insurance company expense loads
  • Reinsurance marketplace potential
  • Tax and regulatory issues
  • Desired captive design

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.

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