Establishing a captive programme can seem a daunting prospect, but there are many reasons for companies to make the effort. Steven Lorady of Carr, Riggs & Ingram discusses three of them.
There are many potential benefits to be gained through ownership of a captive insurance company. The most commonly cited are the retention of underwriting profits within the organisation, greater control over the claim management and underwriting process, increased underwriting flexibility, access to global reinsurance markets, and favourable tax treatment compared with traditional self-insurance.
“In many cases, a captive insurance company can deduct its estimated liabilities for losses that have occurred but have not yet been reported.”
However, the benefits of captive ownership can span beyond these basic benefits if it is managed and used effectively:
1. Flexibility for hard-to-insure and emerging risks
Captive insurance programmes are notable for their flexibility, especially within the emerging risks markets. The commercial market is often hesitant to underwrite new and emerging risks, where the risk of loss is hard to quantify due to a lack of historic data, or other underwriting concerns.
A captive can be utilised to fill in coverage gaps that exist in commercial policies, underwrite risks that are not available on the commercial market or to provide coverage limits that are hard to insure commercially.
Examples of risks that are often hard to insure in the commercial marketplace include cyber risk; loss of electronic medical records; telehealth and telemedicine coverages; loss of key third-party payor coverage; breach of privacy coverage; regulatory change coverage; batch claim coverage; and legacy risks of acquired organisations.
2. Potential tax benefits
Tax benefits should never be the driving focus for forming a captive insurance company. Such benefits are often small compared with the risk management benefits creating a captive can bring.
However, there are key tax benefits that can be derived from a captive insurance arrangement. First, losses for a self-insured company, or one that has a large deductible built into its commercial coverages, cannot be deducted until the loss event actually occurs. In many cases, a captive insurance company can deduct its estimated liabilities for losses that have occurred but have not yet been reported, allowing for quicker tax deductions on losses.
Additionally, smaller captive programmes whose overall premiums written are below $2.3 million, and who meet certain other criteria, may be able to accumulate underwriting profits within a captive insurance company tax-free while the provider organisation takes a deduction for the premiums paid into the captive. This is because 831(b) captives (those that may be taxed under Internal Revenue Code §831[b]) are taxed only on their investment earnings.
3. Increased control
Captive insurance companies can provide their parents with increased control over the underwriting, claims management, and investment processes. In the underwriting process, they can customise their coverage by removing standard items that are not needed, or adding tailored coverage lines that may be limited or not available in the commercial marketplace.
Captives also allow parent companies to exercise more control over deductible and self-insured retention layers.
On the claims management side, commercial insurers have become quick to settle claims in an effort to manage their overall litigation costs, which can often result in unfavourable losses for provider organisations, especially those with large deductible layers or self-insured retention layers built into their commercial policies.
A captive programme gives the parent organisation increased control over its claims management process, allowing it to manage internally or appoint its own third-party administrator for claims. This allows the company to be more selective over which claims should be litigated and which claims should be settled, allowing for effective management of those claims.
The captive also allows for greater control over the investment of premium dollars, allowing the parent to align its premium financing with its risk management goals.
Steven Lorady is a partner at Carr, Riggs & Ingram. He can be contacted at: firstname.lastname@example.org
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