A captivating possibility

“Our company has not had claims; why are our insurance premiums increasing?”

Clients have posed this question countless times to our team at Commercial Insurance Associates LLC (CIA). Because insurance typically is a top-three expense on a company’s profit and loss statement, more companies have wondered, “What can we do about it?”

As insurance professionals, we commonly tell these waste and recycling companies to look no further than a captive insurance program.

What are captives and how do they work?

Captives are a way to escape the ebbs and flows of the standard insurance market and stop paying for the losses of bad operators that are passed through as increased premiums annually.

Three types of captives are most common.

Single-parent/pure captives are the most widely used captive structures today. This is an insurance company owned by a single insured entity. It provides some risk financing or risk transfer for corporations. In most cases, it is not permitted to write insurance for parties other than for the insured entity that owns it.

Typically, these types of captives are used by larger companies to insure against property and casualty risk and to provide employee benefits. They typically are tax-advantaged.

Insureds or corporations that own these captives typically need to capitalize them so that they have sufficient funding to bear risk.

The next option is a rental captive, which is capitalized already by a corporation, captive manager or insurance company. It allows an insured company the ability to transfer risk to the captive by paying a premium.

Unlike with a single-parent/pure captive, no upfront capitalization costs are required; however, the annual continuous cost to a company is higher.

Group captives are the third option, and they are either homogeneous captives or heterogeneous captives.

Homogeneous captives are comprised of member companies from the same industry. Because all members have similar insurance and risk management needs, coverage and loss control can be tailored to each captive’s specific industry needs.

Heterogeneous captives are comprised of member companies from diverse industries that can range from scrap metal recyclers to libraries. The resulting risk diversification and spread of risk are why our agency highly recommends opting for heterogeneous captives.

Business owners who want to join a captive need to be safety-conscious, accountable and have a strong balance sheet. Losses, safety culture and corporate culture are heavily scrutinized during the underwriting process, and only the most well-ranked businesses are accepted.

What do Captive Costs Pay For?

New member costs include an “A” loss fund, “B” loss fund, reinsurance, claims administration, loss control and other operating expenses. Collateral also is required in the form of a letter of credit or cash, which can be paid out in three equal installments over three years.

The “A” fund provides for frequency losses of up to $100,000. These losses are small, low-cost frequency events that members are required to pay to the loss bucket, with prefunding determined by the captive.

The “B” fund provides for more serious losses ranging from $100,001 to $500,000. This layer is considered the “Black Swan” event fund. The “B” fund pays for catastrophic claims should they occur and also is subject to risk sharing in the event that other members’ funds have been exhausted.

Captives are fronted by A.M. Best “A”-rated insurers. Any loss over the “B” fund loss limit will be paid out by the reinsurance markets.

If a member company exceeds the actuarial projections, a stipulation for assessment is built in. This helps for two reasons: ensuring adequate funding and creating an incentive for members to focus on loss prevention and claims management.

Privacy is an added benefit of the fronted insurance paper; when certificates of insurance are issued, they do not reference the captive, so no other company will know that your company is a member.

Advantages of captives

CIA has put dozens of our clients into captives, and the success rate has been phenomenal. Our clients love captives for a variety of reasons. Given the rigorous underwriting process, captives can save a company money on its auto liability, general liability and workers’ compensation programs. The underwriting method allows the captive to estimate the total amount of losses accurately and charges premium commensurate with it.

In addition to saving on liability and workers’ compensation, based on CIA’s data, long-term captive members have been able to improve their claims experience. The reduction of losses and premiums also has resulted in below-market pricing for umbrella and excess liability layers in the standard insurance marketplace.

Claims management

Captives employ third-party administrators who are assigned only to the specific captive, with a restriction on the number of claims they can handle, usually up to 50. Unfortunately, in the years since the onset of the COVID-19 pandemic, the workforce has been slow to return to work, leaving companies short-staffed, including standard market claims adjustors who are forced to juggle up to 200 claims at a time. Standard market adjustors are slow to respond and quick to pay out, which leads to larger-than-necessary losses.

Members work every step of the way to help keep claims costs down and fight claims identified as fraud. Members are given an online portal where they check on the status of a claim, day or night, 365 days a year.

Loss control

Captive members are provided a loss control program tailored to their businesses. An annual, two-day risk control workshop focuses on relevant issues facing environmental, health and safety experts. Risk control webinars are hosted monthly reviewing safety, loss prevention, claims management and more. Personal loss control consultants audit members’ safety programs, review early return-to-work programs, conduct mock department of transportation audits, provide mock Occupational Safety and Health Administration site visits and other safety-related tasks.

Turning a liability to an asset

Standard insurance market premiums are considered a sunk cost for well-run, safe businesses because no incentive is offered for a best-in-class business to continue safe practices with its premiums going up year after year.

Captives are great in the sense that they are truly an investment, and members can receive tax advantageous dividends after three years. The dividends can be distributed into a trust for personal reasons, reinvested back into the businesses or used for future premium costs. Year over year, our captives have outperformed the S&P 500 in investment income percentages.

Captives are an outside-the-box method to escape the standard insurance market. They provide numerous benefits, such as cost savings, risk management and return on investment income for well-run operators.

The author is director of mergers and acquisitions at Brentwood, Tennessee-based Commercial Insurance Associates and can be reached at cskufca@com-ins.com.