Benefits and Risks of Captive Insurance

Captive insurance companies exist to insure the risk of their owners. A large corporation may be owned by a larger holding company, or parent company. This parent can purchase or form a captive insurance company, meaning the corporation and the insurance company share the same owner. The captive can then insure the corporation, setting up a system that is similar to "self insuring." Companies who elect to own their own captives have a large amount of insurance costs that can be partly reduced through private ownership. While the idea sounds attractive, there are several factors that make this choice very risky as well.

Cost Analysis

A captive insurance company still charges premiums to the company it insures even though that company is a "sister." However, since the captive is not looking to make a large profit and can be run with relatively low overhead, it can afford to charge much lower premiums to the sister company. This means insuring through a captive can save a business a lot of money. On the whole, though, to recognize substantial savings, that business must have extremely high premiums each year with a traditional insurer. The cost to establish and capitalize a captive insurance company, often in excess of millions of dollars, will be higher than the savings if the original company does not have high premiums in its current situation.

Flexibility to Market Conditions

One benefit of a captive is its ability to remain flexible to market conditions. A "soft" insurance market is one where claims are low, and premiums are low as a result. In this period, a captive can keep premiums constant, building up its reserves for the future. Then, when the market "hardens," i.e. claims rise and drive up the cost of insurance, the captive can keep its premiums constant. This flexibility allows a captive to constantly insure a sister organization at one rate rather than enforcing premiums based on the market at hand.

Ease of Claim Processing

Many businesses want a captive insurance company for the sole purpose of cutting out the middle man when it comes to making a claim. Standard insurance companies can take a long time to pay out a claim, and this gap in payment may go hand-in-hand with lots of paperwork. Owning a captive can drastically reduce both the cost and hassle of working with a third-party insurer. However, this is only true if the individuals employed by a captive have the sophistication and expertise to process claims efficiently. This is one area where many captives fall short.

Regulations and Oversight

There is a common misconception that international captive insurance companies are subject to far less regulation than insurer's in the United States. This leads many to believe they can be operated "on the cheap." On the contrary, each international domicile has unique rules, most of which set high capitalization minimums and strict requirements regarding who can establish an insurance company. Further, if a business operates within the United States, it will have state insurance requirements that govern whether the captive will be permitted to write the required insurance lines of the business at any given time.

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