In an effort to reduce costs and take control of their property and casualty insurance program, some companies are forming their own insurance companies.
These insurance companies, called captives, are set up primarily to insure the risk
of their owners.
“Instead of purchasing their insurance
from traditional insurance carriers, some
companies are forming a captive insurance
company either by themselves or with
other companies,” says Bill Selman, a producer for The Graham Company in
Philadelphia.
Smart Business talked to Selman about
how captive insurance works and who can
take advantage of it.
Is captive insurance a new concept?
Captives are not new. In fact, they’ve
been around for a long time. There are over
5,000 captive insurance companies in existence today. Fortune 500 companies have
independently owned captive insurance
companies for decades.
What about group captives?
Group captives are a newer concept.
When companies aren’t large enough to
own their own captive, many of them partner with other mid-sized companies to
form a group captive. Group captives
involve anywhere from a handful to over
100 middle-market companies that come
together with a set of service providers to
provide primarily three types of insurance
coverage. They are normally workers’
compensation, general liability and business automobile coverages.
For what kinds of companies would group
captives make sense?
Size matters. Premiums should be at least
$400,000 for the coverages discussed earlier. The organization should have good safety and loss-control procedures in place,
and at least a little bit of an entrepreneurial
spirit. These companies have an interest in
taking greater control of their insurance program as opposed to simply placing the
insurance coverage and forgetting about
insurance for the rest of the year. These
owners want to actively engage themselves
in safety programs, claims programs and
hiring practices. They recognize that if
their losses are favorable they can take
advantage of the profits that are associated
with that performance.
What are some of the benefits of captive
insurance?
There are three primary benefits of captives: increased control, reduced cost and
greater stability.
Captive ownership provides increased
control over your destiny. You choose your
own partners, select your claims administrator, your re-insurer, etc. You have closer
control over how specific things will be
managed and you can customize your loss
control and safety services to meet your
needs.
Second, you can reduce the overall costs
of insuring your risks. Your contributions
are based on your own expected losses. If
you have favorable losses, after approximately four years, you begin to take the
underlying profit and the interest income
as a dividend.
Third, as a group of insureds you are generally able to negotiate broad coverage
terms and stable pricing despite the
inevitable swings of the marketplace.
Are there disadvantages?
Yes, at least perceived disadvantages.
One, if you’re not committed and do not
have a good loss performance, your costs
could be higher than they would be had
you simply bought a traditional guaranteed
cost insurance program. Companies that
aren’t able to adequately control losses
over the long term will suffer.
It’s really only suited for companies that
want to get involved with owning an insurance company. It’s not a dramatic additional amount of time spent, but there are typically two board meetings a year and some
new loss control efforts. And on some level
you do have an exposure to other member’s losses. There is some shifting and
sharing of losses among members,
although it should be structured in a way to
minimize that exposure.
Are all captives the same?
No — each captive is a least a little bit different. Before moving ahead, it’s very
important to thoroughly analyze a potential
captive solution to be sure that you understand its structure and the character of the
other members. It is also important that all
members be big enough to pay their own
major claims without creating loss sharing
after a single ‘shock loss.’ If you are in a
captive with 50 or 100 other companies,
you will not achieve your objective of
being a real ‘owner.’
BILL SELMAN is a producer for The Graham Company. Reach
him at (215) 701-5233 or [email protected].
