Considering a Captive to Leave the Commercial Insurance Rat Race

By Joel Geddes III

A captive will provide a long-term financial approach to someone willing to consider taking risk. In the short-term, use of a captive may be a more expensive option than purchasing coverage through a commercial insurer. In fact when a commercial insurer knows they are quoting against a captive the cost of its commercial insurance program can miraculously decrease. Captives on the other hand are less likely to engage in a price competition while offering long-term customized business solutions and exclusive risk financing.

Price competition is one of the factors that drive insurance market cycles. The most obvious example for California employers has been the workers’ compensation rates over the last dozen years. As we have seen in some cases, continued under-pricing may lead to insurance companies becoming insolvent. Many businesses see the benefit of removing themselves from the large swings in the commercial market. One way of mitigating the fluctuations is to finance a retention layer within a captive, and use a commercial insurer for layers above the retention. The larger the retention layer selected, the less impact market cycles will have on a business’s overall insurance costs.

Utilizing a captive as part of an organization’s risk management program can bring many benefits to a business. These benefits generally come in multiple areas. The first is the reduction of losses; commonly an organization will use more robust loss prevention and loss control mechanisms when claims are paid out of their own captive company. A captive company can reduce claims costs by selecting a specialized claims administrator to handle claims to the best outcome for the business instead of that of a commercial insurer. This advantage can also address reputation management with regards to claims settlement for businesses particularly concerned about the media impact from a settlement.

Awareness and claims prevention are a big piece of the pie when it comes to reduction in costs over a traditional insurance program. Selecting a retention layer within your captive will also eliminate many costs an insurance company is burdened with; large physical overhead, shareholder expectations, subsidization of poor performing business and executive/management teams to name a few. The more risk you choose to take, the more you will pay towards your captive insurance company and less premium will go towards the commercial insurers covering your catastrophic losses.

Every business has different needs and the commercial insurance market puts you in a box with anyone holding a similar SIC code. A captive may be the way for you to create your own custom risk management program that will help take your business to the next level. The decision is not one to be taken lightly and should be made only after considering all the appropriate Alternative Risk Management practices available to your company.