Captives
By the 1960’s captives saw an increase in growth and really started to take off. The 1970’s and 1980’s represented a period of tremendous growth in captives in response to a difficult insurance market and the difficulty of obtaining product liability coverage. Captives have been used very successfully for large corporations like the Fortune 500 however, mid-market businesses from a range of industries are now using captives as a solution to mitigate the risks inherent in their industry.
Today, there are over 7,000 captives in existence which create commercial, economic and tax advantages to the companies that create them. Captives are financial vehicles for the cost reductions they help create, the ease of insurance risk management, and cash flow flexibility. Additionally, they provide coverage for risks that are neither available nor offered in the traditional insurance market and at more reasonable prices. Captives can also offer cost savings by eliminating or decreasing administrative costs and broker commissions. Further, the premiums can be invested to enhance a company’s financial strength generated by underwriting profits. Contributions to a self-insurance pool are not recognized by the IRS to be tax deductible business expenses, although the actual (claims) losses are deductible as they are paid. Premium payments to an insurer are, however, permissible business expenses that may used as an offset to taxable corporate profits.
Captives work in a variety of businesses and industries and can insure against almost any risk.
Many companies have a high-risk profile and a captive can insure against any kind of risk, especially those not available for coverage under traditional insurance plans. Captives are a long-term investment and the company must have the funds or financing to create and manage one. Generally, businesses that pay premiums in excess of $500,000 per year are good candidates due to the inherent costs of forming and operating a captive insurance company.
A captive is a financing mechanism that allows companies to accrue the largest amounts possible to pay for claims and liabilities. Businesses can stabilize their insurance rates by underwriting their own risks. This can cover things such as worker compensation, commercial general liability insurance, auto claims and employee benefits and more, even a major pandemic!
Here are some of the other benefits:
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1. Stability of Insurance PremiumsBecause a captive can set its own insurance rates and customize is own coverage and policy terms premiums begin to stabilize. A captive determines its own premium rates based on its own history of claims and losses. They are no longer affected by the market fluctuations in premium rates.
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2. Improved risk managementIt is in the company’s own financial interest to implement and adopt strict risk management policies and practices. Captive owning companies generally put a bigger effort into minimizing risk as they have a direct interest in the ownership of the captive and hence, its financial results. This directly impacts the amount of their premiums and overall profitability.
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3. Savings in CostsAlthough captives incur costs, they are much lower than what would be incurred in the commercial insurance market. Savings arise from the elimination of the profit component of retail market insurance and from the reduction in commissions and expenses.
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4. The ability to exercise controlCaptive premiums are not directly subject to variable and often unpredictable commercial insurance markets. In contrast to commercial markets, the captive and its insureds receive an immediate economic reward for controlling risks and losses.
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5. Increased cash flowCaptives can provide significant cash flow benefits not available in the traditional retail insurance market. The captive benefits from reduced costs for infrastructure which results in lower premiums to its policyholders and increased profits to its owners.
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6. Favorable regulationsThe insurance industry is heavily regulated, with minimum capital and surplus requirements, solvency margins, specific ratios of premiums written to net assets and, in some cases, restrictions on investments. Captives are generally subject to less regulation than conventional insurance companies.
