Captive Basics
Captive Basics
A captive lets a business self-insure its smaller, predictable claims while still buying protection for the large ones. It sits between a guaranteed cost policy and full self-insurance.
Start a conversationThe Employer Success ProgramSelf-insuring your business risks
The idea behind a captive is self-insuring your risks. You might think self-insurance is too much for you. But every business already self-insures to some degree. If you buy an insurance policy, you have a retention you are paying yourself. It is called a deductible.
Most businesses do not want to pay a large, unpredictable $1,000,000 claim out of their own pocket, so they buy a policy. Usually it is a guaranteed cost policy, which means that other than the deductible, they pay no more than the premium.
Businesses that work at preventing claims through safety and culture often take on some risk to lower their premium. They might keep the first $1,000, $10,000, $25,000, $50,000 or more of any claim and let the insurance company take the rest. They know the more they keep, the lower the premium, and that most of what happens will be small, not catastrophic.
A captive works a lot like taking a larger deductible. It lets you control what you ultimately pay for your protection, and you benefit when you do better than the worst case.
Insurance companies buy insurance too
Insurance companies have the same concern about big claims. They do not want to carry millions of dollars in claims alone, so they buy their own insurance, called reinsurance. They keep a portion of each claim, say the first $250,000 or $500,000, and let the reinsurance handle the large ones. Because a claim over $250,000 is unlikely, reinsurance costs far less than the insurance on that first $250,000.
That is where most of an insurance company's premium, and most of its profit, comes from: the small, predictable claims. The large, unpredictable claims are passed to reinsurers.
The insurance side
From the insurance side, a captive program looks, acts and feels like a typical guaranteed cost program. You buy a standard policy from a regulated insurance company and pay premium to it. The insurance company, or an approved third party administrator, pays your claims. Your premium is deductible for taxes, and you still have a year-end premium audit. No one outside your company will know you own part of a captive or that your policies are reinsured by it.
The captive side
This is where things change. Your captive lets you, alone or as part of a group, fund and pay for the smaller, predictable claims. The underwriting and investment profit that would normally go to the insurance company goes to you or the group instead. You go around the traditional model and reach the reinsurance market directly for the large claims.
Instead of an insurance company issuing your policy on its own paper and keeping the risk, a captive uses a fronting insurance company. The fronting company keeps a small percentage fee for issuing the policies and handling regulatory and state or federal filings. It then buys reinsurance from your captive and sends it the remaining premium. The fronting company is just what the name says, the outward face of your program.
So your captive is really a reinsurance company for your policies. You or your group insure the smaller, predictable claims and buy your own reinsurance for the large ones.
How the money moves
Your captive manages and pays the claims for you or your group. After claims and expenses are paid, if the captive took in more than it spent, it has an underwriting profit that may come back to you as an owner. That money comes back over a number of years, as each program year's claims settle and the year is closed.
Like any insurance company, your captive should not carry all of the potential claims alone. It buys reinsurance to limit what it can pay out. With that reinsurance, the captive works much like a high deductible program. It pays each claim up to a fixed point, such as $250,000 or $300,000, and it pays all claims combined up to an aggregate limit. Once either limit is reached, the excess reinsurance pays the rest. That reinsurance caps what you can pay out for claims in a year.
In a group captive, the loss fund is usually split in two. Your A fund pays your own claims. The B fund is a shared layer that all the members pay into, and it pays the part of a large claim above the A fund's limit. Reinsurance sits above both.
Members also post collateral to back their obligations, and if a year goes badly for the group, members can be assessed for more.
The costs and the investment income
A captive is an insurance company with operating expenses. On top of the premium that funds your claims, you pay for the fronting company, the captive's reinsurance, the third party claims administrator and the other normal costs of running an insurance company.
Premium the captive receives is not spent right away. It is set aside as reserves to pay claims. While the captive holds that money it can be invested, and the earnings are available to pay claims or to be returned to the owners as profit. So investment income can help pay for your claims or come back to you.
Turning Premiums Into Profits
David Leng's book on captive insurance is written for business owners who are tired of the same insurance cycle every year. It explains how a business paying more than $100,000 a year in premium can take on some of its own risk in exchange for the potential rewards, and why captives have become the most widely used way to do that.
Watch: what a captive is
Where the Employer Success Program comes in
It starts with a Diagnostic and Plan. We read your loss runs, your mod worksheet and your key contracts, and we talk with the people who run the work. You get the pattern behind your claims and a short list of what's worth fixing first.
From there our claims, HR, safety and fleet people work alongside yours, and you get a Score Card at the start and every year after, measured against your own starting point.
Start with a conversation
Tell me what's going on. I read these myself and reply within two business days. If there's nothing worth fixing, I'll tell you that too.