Is a captive right for you?

Not all organisations are good candidates for the formation of a captive insurance company.

Captives tend to make the most sense for organisations that:

1. Are comfortable with managing their risks internally;
2. Are comfortable with the retention of certain levels of risk;
3. Have competent risk management professionals in place to lead the captive programme; and
4. Have historical losses that are below average for their industry.

Typically, these organisations may already have large deductibles or self-insured retentions built into their coverage lines. They often feel their insurance is overpriced, based on their favourable loss history.

Any company that is looking for coverage that is either not attainable in the commercial market or hard to place may also be a good candidate.

Captive insurance arrangements will typically be feasible only for organisations with premium volumes large enough to allow for the benefits of captive risk management to outweigh the costs associated with forming and operating the captive.

The premium volume required for captive feasibility is not a hard and set number, but is variable based on the specific captive programmes being designed and the scope of those programmes.

Feasibility studies usually recommend at least $1,500,000 of annual premium volume for a single parent captive, whereas participation in a group captive would usually require $500,000 of annual premium volume. For smaller entities, where group or single parent captives are not feasible, there is another arrangement available through a “rent-a-captive” structure that can make programmes as low as $250,000 in annual premiums become feasible.

The initial startup and annual operating costs for a captive can vary depending on the complexity of the programme and structure, but the initial startup costs for a standalone single parent captive typically start at around $80,000 and would include the costs of a programme feasibility study, legal services, initial actuarial review on programme pricing, and tax opinions, if required.

In addition to this startup expense, captives will need varying levels of startup capital depending on the captive structure and the risk exposures being insured to insure the solvency of the captive. Regulators in the state of domicile also require a minimum level of capital to operate.

The ongoing costs of management typically range anywhere from $80,000 to more than $120,000, depending on the size and scope of the programme. These costs usually include the captive management fees, annual or semi-annual actuarial analysis, and annual audit and tax preparation services. These fees are common in a single parent captive environment; for smaller programmes, the cost can be much lower.

Captive insurance companies are not designed to be short-term solutions, but rather a longer-term strategic plan for managing their organisations’ risks. It often takes several years for a captive programme to mature and realise the full potential of the available benefits.

Formation process

While the process for forming and starting a captive varies depending on the type of captive being formed, the general process begins with a captive manager or consultant who works with the company’s risk management team to identify its risk mitigation needs and captive opportunities. This is usually done in conjunction with a full enterprise risk management analysis.

Once the specific coverage lines needed are identified and coverage levels are determined, a feasibility study can be performed to develop the premium pricing and capital requirements for the designated coverage lines, the expected formation and annual operating costs, and the pro-forma financials for the captive.

After this, a formal business plan is drafted and submitted to the state of domicile for licensing approval. Any fronting carriers and reinsurance providers will also need to be secured, as well as service providers such as accountants, attorneys, and third party administrators.

The time from start to finish can be three to six months, but varies depending on specific circumstances.

Lastly, when exploring the alternative risk management market for the first time organisations should understand that it is not an all-or-nothing approach. Most organisations never entirely abandon the commercial insurance market. Rather, captive programmes are often designed to work hand in hand with a company’s commercial policies.

The captive can manage the higher frequency and more predictable risk layers, while allowing either traditional coverages or reinsurance placements to cover most or all of the provider’s catastrophic risk layers.

At Carr, Riggs and Ingram, we have dedicated teams within our insurance and healthcare practices ready to advise you regarding how your organisation can benefit from establishing a captive insurance company.

Scott Bailey is a partner at Carr, Riggs and Ingram. He can be contacted at: sbailey@cricpa.com