The ABCs of Captive Insurance

By Conor Moran, Assistant Vice President – Commercial Lines

What is captive insurance and is it a good idea for your workers’ compensation coverage? Captives are formed by companies as subsidiaries whose sole purpose is to insure the risks of their corporate parents. They are especially useful in situations where conventional insurance that meets your unique needs is unavailable or the price is exorbitant due to the degree of risk involved. A captive allows you to essentially pay insurance premiums to your own corporate structure rather than an outside carrier, garnering the opportunity to profit from your captive’s investments.

Although captive insurance companies have been around since the 1980s, they have mostly been used by large companies that could afford to take on the risk. More recently, however, the structure has been implemented by small- to mid-sized companies too. Good candidates for establishing a captive insurance company include businesses that:

Want to have better control over their workers’ comp programs, with more streamlined administration and faster turnaround times;

Have sufficient business risk to support the premiums;

Have consistent, free cash flow of at least $500,000 per year; and

Are willing to commit to a long-term strategy to control their risk.

While captive insurance premiums are tax deductible, the IRS has cracked down sharply on businesses using their captive insurance companies as tax shelters, and they have fallen out of favor with some business owners. Yet when established and reported properly, they can be a great idea for workers’ comp insurance plans.

With a captive insurance company, businesses no longer need to rely on the whims of the commercial market with its accompanying volatility and threat of policy cancellations. By managing larger retentions backed by your captive, you can achieve potential premium savings of 20 percent or more, along with a potential return on your investment from funds otherwise paid to an insurance carrier. In a down year, you can minimize losses with protection through prefunding and reinsurance.

The key to success in the captive market is to only assume reasonable risk, with premiums calculated by an independent actuary. You should implement a proper governance structure, directed by the captive owner, and maintain a conservative and reasonably prudent investment portfolio. Be sure to maintain consistency in your claims guidelines and don’t try to adopt a “we cover everything” approach. Finally, locating your captive in a highly receptive captive domicile can be helpful as individual states can vary on this issue.

One of the best features of captive insurance is the fact that you have control.

If a valued worker is awaiting compensation following an injury, you can ensure that he or she is kept on track toward recovery with timely reimbursements, rehabilitation program approvals, and other medical allowances. If a “worst case” catastrophe hits, you can be sure you’re ready and staffed appropriately to handle your needs.