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Is a Captive Right for Your Organization?

Mar 18, 2020

Not all organizations are good candidates for the formation of a captive insurance company. In most cases, captives tend to make the most sense for organizations that

  1. are comfortable with managing their risks internally
  2. are comfortable with the retention of certain levels of risk
  3. have competent risk management professionals in place to lead the captive program
  4. have had historical losses that are below average for their industry.

Typically, these organizations may already have large deductibles or self-insured retentions built into their coverage lines and often feel their insurance is overpriced based on the favorable loss history. Additionally, any company that is looking for coverage that is either not attainable in the commercial market or hard to place may also be a good candidate.

Captive arrangements will typically only be feasible for organizations with premium volumes large enough to allow for the benefits of captive risk management to outweigh the costs associated with forming and operating the captive. The premium volume required for captive feasibility is not a hard and set number but is somewhat variable based on the specific captive programs being designed and the scope of those programs. However, general guidelines typically recommend at least $1,500,000 of annual premium volume for a single-parent captive, whereas participation in a group captive would usually only require $500,000 of annual premium volume to be feasible. For smaller entities, where group or single parent captives are not feasible, there is another arrangement available through a “rent-a-captive” structure that can make programs as low as $250,000 in annual premiums become feasible.

The initial startup and annual operating costs for a captive can vary depending on the complexity of the program and structure; however, the initial startup costs for a stand-alone single-parent captive typically start at around $80,000 and would include the costs of the program feasibility study, legal services, initial actuarial review on program pricing, and tax opinions if required. In addition to this start-up expense, captives will need varying levels of startup capital depending on the captive structure and the risk exposures being insured to insure the solvency of the captive. Regulators in the state of domicile also require a minimum level of capital to operate.

The ongoing costs of management typically range anywhere from $80,000 to $120,000+ depending on the size and scope of the program and these costs usually include the captive management fees, annual or semi-annual actuarial analysis, and annual audit and tax preparation services. Keep in mind that these fees are common in a single-parent captive environment; however, for smaller programs, the cost can be much lower.

Captive insurance companies are not designed to be short-term solutions, but rather a longer-term strategic plan for managing their organization’s risks.   It often takes several years for a captive program to mature and realize the full potential of the available benefits.

Formation Process

While the process for forming and starting a captive may vary depending on the type of captive being formed, the general process begins with a captive manager or consultant who will work with the Company’s risk management team to identify the Company’s risk mitigation needs and captive opportunities. This is usually done in conjunction with a full enterprise risk management analysis.

Once the specific coverage lines needed are identified and coverage levels are determined, a feasibility study can be performed to develop the premium pricing and capital requirements for the designated coverage lines, the expected formation and annual operating costs, and the pro-forma financials for the captive. After this, a formal business plan is drafted and submitted to the state of domicile for licensing approval. Any fronting carriers and reinsurance providers will also need to be secured as well as service providers such as CPAs, attorneys, and third-party administrators.

The time from start to finish can be three to six months but is variable depending on the individual.

Lastly, an essential item for organizations to understand when exploring the alternative risk management market for the first time is that it is not an all-or-nothing approach. Most organizations never entirely abandon the commercial insurance market. Rather, captive programs are often designed to work hand in hand with a Company’s commercial policies, allowing the captive to manage the higher frequency and more predictable risk layers while allowing either traditional coverages or reinsurance placements to cover most or all of the provider’s catastrophic risk layers.

By engaging with the best insurance and healthcare advisors, your organization may be able to benefit from establishing a captive insurance company. Contact your local CRI advisor today and see how you can transform your enterprise risk management strategies into a competitive advantage.

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