If you're considering captive insurance for your business, you may be wondering about its potential financial advantages and drawbacks compared to traditional insurance models.
For businesses who qualify, captive insurance offers an alternative approach that could better align with your needs as a company looking to reduce costs and regain control.
As a broker or business owner, this article will help you comprehend captive insurance's financial pros and cons. That way you'll understand if captives are the right fit for your needs.
The Financial Advantages of Captive Insurance
Solutions that provide transparency, control, and cost-efficiency are valuable for any business. Here's how captive insurance delivers on those priorities:
- Customized Premiums Based on Your Company's Real Risk: Unlike traditional insurers, which base rates on market averages, your captive premiums are calculated using your actual loss history and risk management efforts. This puts you in control of influencing costs by improving safety.
- Those Underwriting Profits? They're Yours: With a captive, the underwriting profits an insurance carrier would typically keep stay in your captive entity. Well-run captives can reduce renewal premiums by around 28% over 3 years, with a 25% cash flow boost from retained profits.
- Invest Your Premiums for Additional Income: Rather than premiums going to an external insurer, those funds remain assets you can invest and grow, generating extra income streams and asset growth over time.
- True Transparency & Control Over Insurance Costs: By assuming select risks directly through your captive, you have clear visibility and control over insurance expenditures. Effective risk management reduces claims payouts for real long-term savings.
- Tax-Deductible Premiums, Tax-Deferred Growth: Premiums paid into your captive insurer are tax-deductible business expenses. Plus, any underwriting profits and investment income accumulated in the captive are tax-deferred until distributed out.
For companies already spending $250K+ annually on commercial insurance premiums, these advantages can lead to significant cost savings and boosted cash flow when done right.
The Potential Financial Disadvantages to Consider
But I'd be misleading you if I didn't also lay out the potential drawbacks of the captive model. It's not a magic solution for every company:
- Upfront Capital Investment Required: Establishing a captive requires funded reserves and collateral based on your risk exposures. This initial capitalization can be a major barrier.
- Risk of Losing That Invested Capital: If claims exceed projections, your captive's capital may be used to pay them, potentially requiring an additional cash injection to remain operational. Proper claims forecasting is critical.
- Reinsurance Market Factors: While captives are less exposed overall, volatility in the reinsurance market can still impact pricing and availability of required reinsurance coverage.
- Premium Cash Flow Timing: Captives require consistent premium payments from your operating business each year, which impacts short-term cash flow planning.
- "Runoff" Exit Expenses”: If exiting the captive structure, there are expenses to properly run off remaining claims until all policy years can close out in 5-7 years.
- Tax/Accounting Compliance: The IRS enforces strict rules regarding what legally constitutes "insurance" for tax purposes. Failure to meet these rules can create costly tax challenges.
Additional Financial Answers Regarding Captives
How Can a Business Owner Make Money with a Captive?
In a captive insurance arrangement, premiums paid to the captive fund potential losses. Typically, 65% of each dollar is set aside for claims. If your business avoids or minimizes claims, the unused funds are returned to you as distributions. Over time, this can lead to significant savings and even profits. Distributions usually start in the third or fourth year, gradually increasing as more policy years close.
What Are the Costs Involved in Joining a Captive?
The costs of joining a captive vary based on the type of captive:
- Single-Parent Captive: Typically requires a minimum premium of $1 million to start your own captive.
- Group Captive: Generally requires a minimum of $250,000 in combined premiums for workers' compensation, general liability, and auto liability. Additional costs include collateral and buying a share to join the captive. These initial premiums are similar to what you would pay in traditional insurance but offer potential savings in subsequent years.
Can a Big Claim Bankrupt My Business in a Captive?
No, big claims will not bankrupt your business in a group captive. Group captives share risks among unrelated entities and often involve a fronting company that covers large claims. For example, if your business faces a $1 million claim, the captive might cover the first $300,000 while the fronting company covers the remainder. This structure ensures that no single business bears the full financial burden of a large claim.
For companies able to make the upfront investment, with strong risk management and claims forecasting abilities, the long-term benefits of captive insurance can outweigh the downsides.
The bottom line? This alternative demands an open, honest evaluation with guidance from captive experts – like the advisors at Captive Coalition. We'll ensure you understand the full financial implications to your unique situation so you can make the right call.
Ready to take control of your insurance? Contact Captive Coalition for a free consultation today.