Traditional insurance has made it difficult for companies to control risk management programs because of their excessive pricing, limited capacity, and coverage that is unavailable for some businesses.  Thus, organizations have leaned into better ways to control their risk management programs like captive insurance.

Captive insurance has been considered to bring many financial rewards including broader coverage, stabilized pricing, and improved cash flow.  Companies are willing to risk their own capital in anticipation of these benefits.  How does captive insurance work?  Take a look at the basics of this risk management program alternative.

What a Captive Insurance Company Is

A captive insurance company is one that is owned by one or more parent organizations that is established primarily to insure the exposures of its owners.

They offer captive insurance which is utilized by the insured who choose to:

  • Put their own capital at risk by creating their own insurance company
  • Work outside of the commercial or traditional insurance marketplace
  • Achieve their risk financing objectives 

Captive insurance is an alternative to self-insurance where a parent group creates a licensed insurance company to provide coverage for itself.

How a Captive Insurance Is Set Up

Many organizations and businesses have a substantial amount of insurable risks that they have to account for.  In order to better deal with these expenses, the company can choose to pay insurance premiums to the captive insurance company rather than an external insurance company.

There are many forms of captive insurance with two categories in which they are set up:

  1.  Non-sponsored

The non-sponsored set up for captive insurance has the company as the creator and beneficiary.  The captive insurers are 100 percent owned, directly or indirectly, by their insureds.  The most common forms in this set up are the single-parent or pure form, group, and association.

  1.  Sponsored

The captive in this setup is owned and controlled by another company that allows other companies to “rent” insurance.  The captives are owned and controlled by pirates unrelated to the insured.  This setup includes the protected cell captive insurance and rental captive insurance.

Five Structures of Captive Insurance

Captive insurance can be established in a way to tailor to each participant’s individual needs.  This results in safer workplaces and a more favorable loss experience.  Here are the different structures of captive insurance that allow the insured to dictate how claims are handled:

  • Single Parent

The insurance is a wholly-owned subsidiary of a parent company, structured to meet individual company needs and potentially third-party risk.  The minimum annual premium is $1.2 million.

  • Multiple Parent/ Group Captive/ Homogenous Captive

The system is owned by a group of companies in the same industry.  The minimum annual premium is $500,000.

  • Heterogeneous/ Association Captive

The captives are jointly owned by companies of similar size but in different industries who pool resources together to form an insurance joint venture.  The minimum annual premium is $500,000.

  • Rent-A-Captive

This system is for companies in the same industry that are not large enough to form their own captive but want the opportunities that owning a captive provides.  Instead of pooling resources, they pay the captive owner a fee.  The minimum annual premium is $250,000 and it depends on domicile.

  • Segregated Cell

It is similar to a rent-a-captive system where the owner of the cell facility owns the insurance license and runs the day-to-day management where each cell is legally separated from the others such that insurance risk, liabilities, assets, and other pertinent information are not shared.  The minimum annual premium is as little as $250,000 and it depends on domicile.

Going Captive or Not?

There has been an increase in the use of captive insurance companies by entrepreneurs and small-business owners.  This is true especially for businesses that deal with a lot of risks where captive insurance can save them from insurance premium hikes.  

In addition to reducing the costs for insurance premiums, they also experience a boost in revenue, get broader insurance coverage, and are able to more efficiently finance risks.  

In order for you to know if captive insurance will work for you, know the risks and benefits that it has to offer and if it fits your particular situation.  It may not be the right solution or it can be a very profitable risk financing option.  It depends.