Demystifying Captives

A captive is an insurance company, whose primary job is to insure the risks of its owner or owners. Captive insurance companies have existed for many years, gaining legitimacy in the 1960s and enjoying steady growth in the 1970s and 1980s. Today, there are approximately 6,200 captives worldwide, with 90 percent of Fortune 500 companies having one or more captives. Captives have become part of the retail insurance fabric and are no longer the exception.

There are four criteria to be considered an insurance company. A captive must be established with economic substance, there must be adequate risk transfer and risk distribution and the captive must operate in accordance with commonly accepted standards of insurance. This is the case whether the entity is a single parent, group or micro captive.

The primary benefits of a captive are financial. A captive allows its owner(s) to participate in the underwriting results of a program that would have otherwise been retained by the carrier in a traditional insurance program.

A favorable loss experience will result in the captive earning underwriting profit. In addition, the captive owner will have control over its service providers and will earn investment income on tax-deferred reserves until a policy year is closed.

There can be specific tax advantages to a captive when formed and managed properly. As for disadvantages, captives involve greater risk assumption and require sharing risk with other companies or within the economic family. As a separate company, the captive requires business and financial management, potentially taking time away from managing the core business.

Workers’ compensation, general liability and automobile liability/physical damage are the core lines of coverage for single parent and group captives. A micro captive acts as an overlay to a traditional risk management program by transferring self-insured enterprise risk to an insurance company.

A group captive is owned by group of like-minded business entrepreneurs. The captive may be made up of companies from the same class of business (homogeneous) or multiple classes (heterogeneous). Group captives are successful because they are composed of the best of the best in terms of focus on safety and loss experience. In most cases, those invited to join a group captive never leave and only improve, as best practices are shared within the group with a heightened focus on risk management policies and procedures.

A commitment to employee safety and product quality, in conjunction with adequate size and proven loss experience, are the key factors. A group captive candidate will have a five-year loss ratio no higher than 60 percent and minimum casualty premium of $150,000.

To learn more about captive insurance programs, please contact Sterling Insurance Group.