Many companies that want to pool their risk together form captive insurance companies to underwrite risk within their groups, enabling them to control their costs.
The captive insurance company takes a portion of every loss, and when the losses are less than expected, members of the group get money back, giving them an opportunity to recover unused loss reserves, says Steven B. Bankes, managing director of Aon Insurance Managers Inc., Group Captive Solutions.
“A group captive is a blend between guaranteed cost insurance and a deductible program,” says Bankes. “It allows a middle-market business the opportunity to participate in its own insurance program. Then, rather than have that insurance program be an annual necessary expense, it becomes a profit center generating annual income for the company in the form of underwriting profit and investment income.”
Smart Business spoke with Bankes about how a group captive insurance company can help your business control costs.
How can businesses create or join a captive insurance company?
Usually they are invited into a captive, typically by a broker. Not all captives are open to new members, although many are. And businesses certainly can seek one out, working with their insurance adviser or risk consultant to find one that is a good fit in terms of their risk profile.
It’s important to find someone who can advise you on your options because there are different types of group captives. There is heterogeneous, in which group members come from different industries, and homogenous, in which group members come from a common industry. Some companies don’t want to be pooled with similar companies, some prefer it. For low- to medium-risk companies, heterogeneous is very common.
But both have proven to be successful, reliable, efficient risk-financing mechanisms.
How do captives work?
Generally, when a company joins a captive, it is leaving a very large pool of risk — the insurance market — to create a smaller, cleaner pool of risk. It’s like going from a public pool to a country club pool.
Once it enters into that smaller pool, it is incumbent upon the company to make sure it not only controls its losses but also invites other companies with a similar commitment to risk control to participate. It’s incumbent upon the company to make sure that its smaller risk pool stays clean, and the best way to do that is to control its own losses and ensure that everyone else coming in has that same commitment.
If the captive chooses to grow, it seeks out other members that share the same dedication to risk control. It’s very much like a club.
How can businesses determine if creating or joining a captive is the right move for their needs?
Companies shouldn’t measure the success of their program a year from now but instead look back and ask themselves what they wish they had done five years ago.
Are they glad they stayed with guaranteed cost insurance? How would their financials be different today if they had been in a captive five years ago? That is a pretty good indication of whether this is a company that is right for captives.
It’s not complicated. Look at the amount of losses they’ve had and compare that to their premiums. If they believe they pay too much for insurance to finance the amount of losses that they have had, they might be a good candidate for a captive.
Why would a company want to get into the business of insurance if that’s not its core competency?
If you are in, for example, the manufacturing industry, it’s common to think, ‘What do we know about the insurance business? Wouldn’t that be a losing proposition for us to step into the insurance business?’
However, if you consider keeping your employees and the general public safe from harm, then you are a good candidate for a captive. That’s because it is all about controlling your workers’ compensation losses and auto liability and general liability losses. If your company’s culture is focused on safety, that makes you a good candidate.
The actual running of a captive insurance company is left to people who do that for a living. You hire a captive manager who runs your company and who, in turn, engages a reinsurer who protects you against larger, more catastrophic losses, and a claim administrator to adjudicate claims for you, although you are generally more involved in the claims process.
So you have professionals on your team handling those areas. Job one for you is to control your losses. Job two is to control your expenses and make sure you consider the captive’s costs every year, just like you do in your own business.
Why is now a good time to join a captive?
Premiums might be down, but traditional insurance doesn’t return unused loss funding and investment income, and in a typical year, this can still be a substantial sum to leave on the table. Over the long haul for a well-managed business, group captives will lower your total cost of risk and increase control and stability over your risk financing program in this soft market. And when the market cycles up, you will be ready, having insulated your company from the impact of rising rates.
Steven B. Bankes, CPCU, ARM, is managing director of Aon Insurance Managers (USA) Inc. Reach him at (312) 381-5109 or email@example.com.