When discussing captive insurance with your clients, one of their primary concerns might be whether they can exit if circumstances change. The short answer is yes, they can. However, exiting a captive requires careful consideration and strategic planning, just like entering one.
This article will explore the reasons a business might exit a captive, the process involved, and why reclaiming collateral may take time.
At the end of this article, you’ll be better prepared to guide your clients through the potential of exiting a captive and help them determine if it’s the right choice for their business.
What Happens When a Business Exits a Captive?
Exiting a captive insurance arrangement is not as simple as deciding to stop participating. While a business owner can technically exit a captive at any time, there are several factors to consider, particularly concerning the capital invested in the captive.
Even though you can leave immediately, any collateral (a line of credit or cash reserve used to secure claims payment) your client has put into the captive will remain tied up until all policy years are closed—usually taking five to seven years. This is because the funds held as collateral are there to cover any claims or liabilities that may arise during that period. Once all obligations are fulfilled and any underwriting profits distributed, the collateral will be returned to the business.
Understanding the Delays in Reclaiming Collateral
One of the key differences between traditional insurance and captive insurance is the requirement for upfront capital investment. In a traditional insurance model, your clients pay premiums without needing to post collateral. If they decide to switch insurers or discontinue a policy, there’s no financial hold-up—they simply stop paying premiums.
In contrast, the captive model requires clients to invest capital upfront to ensure funds are available to cover claims and other costs. This collateral is held until all potential liabilities, including tail liabilities (those claims that take longer to settle), are resolved. Depending on the nature of the claim and the terms of the captive, this could take anywhere from five to seven years.
Additional Scenarios When Exiting a Captive Might Be Necessary
There are several other scenarios where a business might need to exit a captive:
- Business Closure or Insolvency: If a company faces severe financial difficulties or legal challenges leading to its closure, continuing in the captive may not be feasible. In such cases, the business may exit the captive, although they will still need to wait for all policy years to close before retrieving their collateral.
- Acquisition by another company: If a business is acquired by a larger company with an established captive, there’s no need to duplicate insurance efforts. The acquired business’s risks may be rolled into the acquiring company’s captive, allowing the previous captive to be put into runoff. Again, the business must wait for all outstanding policy years to close before reclaiming its collateral.
- Regulatory Intervention: If a captive is not fulfilling its obligations, such as paying claims, regulators might step in and shut down the captive. This can happen if the business generates too many claims without the ability to pay or if there’s a failure in managing the captive. The regulator’s primary concern is ensuring that the captive can meet its financial obligations to policyholders.
Is a Captive Insurer Right for Your Client?
While it is certainly possible to exit a captive, it is not necessarily simple or quick. The process of reclaiming collateral can take years. The decision to exit needs to be as carefully considered as entering a captive.
Next, read our article on the financial advantages and disadvantages of captive insurance. That way, you and your client can carefully weigh the pros and cons before deciding to enter a captive.
For any additional questions about exiting a captive or about captive insurers in general, schedule a call with Captive Coalition to talk to one of our insurance advisors.
