Creating an Insurance Captive Can Bring Broader Coverage, More Cost Control

For all businesses, insurance is a necessity. There are policies to cover the business and its property, policies to cover its employees and owners, and policies to protect against special risks like cyberattacks.

For very large commercial businesses, the total outlay in insurance premiums can add up, and traditional insurance may not even meet certain difficult risks. Purchasing policies from brokerages can be particularly expensive, due to commissions, which can be substantial.

While trusted, experienced insurance brokers are valuable to most businesses, there is a point at which commercial companies should consider creating their own insurance company as a form of formalized self-insurance for the types of claims that are frequent and below $250,000 per occurrence.^*

These companies are called “captive insurance companies” and are formed with the help of specialized service providers. Most large brokerages have sizeable captive insurance arms with captive managers, actuaries and CPAs with attorney partners who are in the business of setting up and operating captives.

In general, if a company is spending $1 million on insurance premiums, professionally and personally by ownership, pure captive insurance is worth a closer look. Those paying $250,000 to $1 million could benefit from joining a group captive in partnership with other businesses, which require a smaller initial investment.

Captives are not a new concept; Fortune 1000 companies have had captive insurance for 30 years. It’s legal and highly regulated, and many states have a reputation for dealing professionally and hospitably with companies seeking a license for a captive insurance company.

Tennessee is in the top 10 having licensed nearly 1,000 captives since its laws were revamped in 2011.  In fact, the state launched its own captive insurance company in 2022 to cover $31.4 billion in state-owned buildings and contents, including public college campuses. Tennessee also uses its captive for general liability.

Benefits of captive insurance include:

• Reduced operating costs when compared to traditional insurance premiums.
• Greater control over risk, coverage, deductibles, and claims
• Underwriting profits stay with the business owner
• Captives can be formed in partnership with other businesses or as a “single parent”
• Potential tax advantages when the arrangement meets certain risk-distribution standards

Some considerations and caveats are:

• The company’s capital is the collateral, so there’s inherent risk.
• Companies can be under-insured if the risks covered by the captive are not complemented by catastrophic coverage.
• There are overhead expenses for operating the captive insurance company.
• Captives have strict compliance requirements and regulations.

When looking for a team to help you set up a captive insurance company, seek out an expert who has formed captives in the past and get references for captive management companies. I was chief captive insurance regulator for the State of Tennessee and would be happy to share my advice.

The team needed to set up and operate your captive includes the manager, an attorney, an actuary and accountant, a banker and an investment manager. Documents drawn up include a business plan, a feasibility study, and bylaws. Once documents are complete, the company seeking license for the captive makes a statutory deposit with the state or gets a letter of credit.

And last but not least: Timing is pretty critical because you need approval in time for coverage to start when traditional policies end. Ask your captive team what the average turnaround time is once the documents are complete. An experienced team will have the letter of credit signed and a license in hand within one or two business days.

 

^*   Companies with captives still need traditional insurance for catastrophic loss, in the form of reinsurance, also known as stop-loss insurance.

 

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