How to determine if a captive program is right for your company

Any company with good cash flow that’s looking to reduce its insurance costs should explore a captive insurance program. These programs can cover all the same risks as a traditional insurance program — workers’ compensation, automotive, employee benefits, etc. — while offering an opportunity to customize coverage.

“Companies that feel they are underinsured in some areas might be better off if they self-insure those particular risks,” says Andrew Seger, general counsel at Imprise Financial. “The decision tends to come down to the company’s appetite for risk, whether it has a favorable claims history and if the cash flow is available to cover its risks.”

Smart Business spoke with Seger about when companies should explore the option of a captive insurance program.

What determines whether a captive program makes sense for a company?
A captive insurance program enables a company to self-insure programs that would otherwise be insured by a third party. Whether a company should self-insure is largely determined by a company’s claims history. If claims are costing more than the premium the company is paying, it’s better to have someone else bear that risk.

A company with high premiums, low claim frequency and palatable risk is a good candidate for a captive program. In other cases, a company may not be able to cover certain risks through a third-party insurer and a captive program may be the only option for coverage.

How do captive programs compare to more traditional plans?
The essential difference between the two options is who bears the risk. Determining which program is best for a company starts with the question of whether the company wants, or is capable of, taking on its claims risk.

Can a company create a financially stable program for the long-term? If so, a captive program offers a chance for companies to write their own policy to cover risks for which it can’t otherwise find acceptable coverage.

Unlike traditional insurance, the company or the company owners own the insurance program that’s run through a captive. That creates revenue and investment options not available with traditional insurance.

What are some of the more significant benefits of captive programs?
Captive programs offer a wide range of benefits, but the draw for most companies is coverage for risks that are uninsured or underinsured. Companies can write coverage specific to their needs as a way to control risks and manage claims more efficiently. This comes into play with companies that see an area for which coverage is eroding because of exclusions.

There are cases in which a company uses its captive program to insure affiliates, customers or vendors. This can become a new profit center for companies, adding value to the bottom line through the creation of a long-term asset.

Tax efficiencies also become available and can be used to make a captive program financially feasible, even for small companies.

What should companies understand about implementation and administration?
Most companies hire a captive manager to handle the implementation and administration of a program. The key is picking a good one. Knowledgeable and experienced captive managers bring a turnkey approach to all program responsibilities so business owners can focus their attention on growing the business.

As the program is implemented, expect the captive manager to communicate regularly throughout the process. It’s a critical aspect of making a captive program work.

Who should companies turn to in order to learn more about captive programs?
Talk with an experienced captive manager, someone who has worked in a captive program and is willing to give candid advice without expecting anything in return. He or she will take the time to explain the program and explore whether the company has the right risk profile for it.

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What to look for in a captive manager

Choosing a captive manager is the most important decision a company makes when it establishes a captive insurance program, so it’s critical to hire the right professional.

“Just because someone has an impressive background as a lawyer or an accountant doesn’t mean they know how to run a captive program,” says Andrew Seger, general counsel at Imprise Financial.

“The more effective captive managers will have several years of direct responsibility for a program, so check their references,” he says. “And whoever is picked should really be excited to get involved with the program. Their attitude is important because they are who a company will be working closely with for a long time.”

Smart Business spoke with Seger about what to look for in a captive manager.

What is a captive manager’s role in a captive insurance program?
Captive managers provide prospective clients with advice on whether a captive insurance program is an option that will meet the company’s needs and goals. They handle the implementation and management of the entire program, and make sure the program stays compliant with all applicable state and federal regulations.

What professional backgrounds do captive managers come from?
People with a variety of professional backgrounds will market themselves as captive managers, such as accountants, lawyers and insurance brokers. Many of them are smart, capable people. But if they don’t have direct experience managing a captive program, they likely won’t understand the nuances and regulations involved, and that can be disastrous for a program.

A captive manager should be devoted to managing a captive program and should be independent, not trying to sell the services or products of an insurance company, or an accounting or law firm. If they require a client to use a certain bank or adviser, for example, there is likely a conflict of interest.

What are the more important qualities to look for in a captive manager?
Look for a proven track record of successful program management. Ask how long they’ve been in business, whether it is their main business or if they do something else, and how many captive programs they have established.

Outside of experience, look for a captive manager who is innovative enough to meet their clients’ needs and goals. They shouldn’t be locked into the status quo, but rather be willing to get creative.

Demand financial transparency from a captive manager. Companies should ask potential captive mangers about their fee structure. Some may hesitate to disclose specific fees or say they’re on a sliding fee schedule. Those are red flags. Look for a captive manager who provides the charges clearly and upfront.

How much time should companies expect it will take to find a captive manager?
All companies move through the process at their own speed, with some taking longer than others to conduct their due diligence. It may be helpful to get recommendations from trusted advisers or clients that know of or work with captive managers. Ultimately, all that’s important is that the company is comfortable with its decision because it will be working with that person for the duration of the program.

Once a decision is made, how can companies gauge the effectiveness of their captive manager?
The best way to check on the performance of a captive manager is to look at the performance of the captive program. It should live up to the expectations set by the captive manager in the initial meetings.

Ensure that the claims being paid by the captive program are consistent with what the captive manager suggested upfront.

Some captive managers pass along hidden fees to their clients that can be tough to spot. That’s why really strong financial transparency is important. Make sure that during checkups the fees are clear and the captive program is performing as expected.

Insights Insurance and Risk Management is brought to you by Imprise Financial