Captive reinsurance versus deductible reimbursement: evolving beyond legacy structures

In terms of the structure of captives, while the deductible reimbursement model remains popular, the economics and flexibility of captive reinsurance structures should not be overlooked, writes Nate Reznicek (pictured), president of Captives.Insure.

For sophisticated brokers and captive managers seeking maximum value and control, captive insurance represents a powerful tool in the modern property and casualty (P&C) landscape. However, the economic performance of a captive is heavily dictated by its structure. While the deductible reimbursement model remains a familiar entry point for many organisations, it is increasingly viewed as a "legacy" approach—one that is being outpaced by the superior economics and flexibility of captive reinsurance structures.

Historically, many businesses built their captive programmes around deductible reimbursement policies (DRPs). Under this model, the insured purchases a high-deductible policy from an AM Best-rated carrier and creates a reimbursement policy within the captive to cover the deductible layer. While conceptually straightforward, this structure suffers from significant inefficiencies that limit a program's long-term potential.

The primary flaw of the deductible reimbursement model is economic restriction. In a DRP, the insured receives "premium credits" from the carrier for taking a high deductible. These credits are often a fraction of the actual premium value, severely limiting the funds flowing into the captive.

Furthermore, commercial carriers frequently cap deductible levels, creating artificial ceilings on the risk a captive can assume. This structural friction undermines the very rationale of forming a captive: to capture underwriting profit and build surplus.

Beyond economics, DRPs introduce contractual fragility. Because the captive sits outside the primary insurance contract, third parties—such as lenders or landlords—may reject proof of coverage from an unrated captive. Additionally, when DRPs involve non-admitted placements, they can trigger complex self-procurement taxes, eroding net savings and increasing compliance burdens.

In contrast, forward-thinking organisations and their advisors are migrating toward structures where the captive acts as a formal reinsurer. In this model, the insured purchases a policy from an AM Best-rated fronting carrier, which then cedes the risk to the captive through a reinsurance agreement. This approach is rapidly becoming the gold standard for mature programs, offering distinct advantages in capital efficiency and market access. These include the following advantages.

Superior premium allocation

The reinsurance model allows the captive to capture the full economic value of the risk. Rather than receiving modest premium credits, the captive receives reinsurance premiums that materially exceed the savings found in high-deductible programs. This accelerates the accumulation of surplus and investment income—a critical driver of long-term program sustainability.

Market credibility & access

By partnering with a rated fronting carrier, the programme issues policies on AM Best paper, ensuring immediate acceptance by regulators and counterparties. More importantly, acting as a reinsurer grants the captive direct access to the global reinsurance market. This allows the captive to purchase capacity at wholesale rates, bypassing retail markups and securing favourable terms unavailable to traditional insureds.

Specific and aggregate reinsurance capacity

One of the most compelling advantages of the reinsurance model is the ability to secure specific and aggregate reinsurance directly from the issuing AM Best carrier. This tiered protection, where the carrier covers losses above agreed-upon specific and aggregate thresholds, provides sophisticated captive managers and brokers with precise risk management and protection of surplus. Rather than relying on third-party reinsurance placements or facultative coverage, the integrated fronting arrangement delivers seamless reinsurance capacity tailored to the captive's risk profile and risk appetite, while enhancing the overall program economics.

Measurable outperformance

The data supports this structural evolution. Recent industry analysis indicates that captive groups leveraging reinsurance structures have achieved combined ratios near 88%, compared to 106% for traditional commercial auto carriers. This performance gap highlights the operational superiority of aligned incentives and sophisticated risk control inherent in the reinsurance framework.

As the captive marketplace matures, the choice between these two models is no longer just technical - it is strategic. Deductible reimbursement acts as a compromise, sacrificing premium economics for simplicity. The future belongs to captives structured as true reinsurers—leveraging fronting relationships to capture the full financial value of retained risk and access the protections and capacity that only integrated reinsurance structures provide.

Nate Reznicek is president of Captives.Insure. He can be contacted at: nate@captives.insure

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