Captive insurance provides a unique opportunity for your clients to gain control and transparency over their insurance premiums. Unlike traditional insurance models, where premium allocation is often unclear, captives allow business owners to see exactly where their money goes and how it contributes to their financial well-being.
As an insurance agent, understanding the allocation of captive premiums is crucial to guiding your clients toward informed decisions.
By the end of this article, you’ll have the knowledge to confidently discuss how captives allocate premiums, determine costs, and support your clients’ long-term financial goals.
Where Your Client’s Insurance Premium Really Goes
When your client pays a premium—whether to a traditional insurer or a captive—the distribution of that premium plays a crucial role in managing their risk and financial planning.
Operational Costs vs. Underwriting Profit
In any insurance model, a portion of the premium covers the insurer’s operational costs. For captives, this typically ranges between 30-35%. These costs tend to decrease as the captive gains experience. The remaining 65-70% of the premium is in a loss fund. This is reserved for covering claims.
Unlike traditional insurance, where much of the surplus remains with the insurance company, captives allow clients to potentially recover a portion of these funds if claims are lower than anticipated.
Understanding Loss Funds
A significant portion of the premium—often around 60%—is directed to a loss fund. The fund is reserved for paying claims and can generate investment income over time. The primary goal for captive owners is to maximize this fund by minimizing claims and ensuring that it grows through careful management.
With a group captive, owners also benefit from loss control programs designed to reduce claims by helping them improve their operational safety and risk management. As businesses become more efficient and safer, they will likely see a reduction in their premium costs.
Collateral Requirements
In addition to premiums, captive owners must provide collateral–a line of cash reserve or credit used to secure claims payment. This collateral is a safety net so funds are available to pay claims, even if the loss fund is depleted.
You might be wondering how your best clients would perform in a captive. Take this captive assessment to get those results.
How Are Premiums Priced in a Captive Insurance Model?
Determining premium costs in a captive insurance arrangement involves a detailed assessment of the owner’s business risks.
The Role of Actuarial Analysis
Captives rely heavily on data from actuaries—professionals in risk management who use math, statistics, and financial theory to analyze the financial consequence of uncertainty to assess risk and calculate premiums. That way, the captive can assess risk and calculate premiums.
Actuaries use advanced statistical methods to estimate the likelihood of claims and potential costs with them. This means that a captive owner’s premium is directly tied to their specific risk profile rather than being based on broader industry averages.
Sometimes, captive managers might pressure actuaries to underestimate the premium, which can lead to underfunding. This is rare but can happen. The result is additional costs that need to be made later if the loss fund is insufficient to cover claims, particularly for smaller businesses.
Accurate funding is important to avoid future assessments.
The Impact of Claims History
As claims history within the captive develops, captive owners can see their premiums being influenced. A strong safety record can lead to lower premiums, especially as the captive becomes more confident in the captive owner’s business.
That said, a poor claims history can result in increased costs, which is why engaging in safety and risk management is necessary.
Managing Challenges with Premium Allocation
Premium management in a captive does have its challenges. Here are some issues to consider:
Frequency of Small Claims
One common challenge is the occurrence of frequent small claims, known as frequency claims. These can erode the loss funds and lead to higher costs over time. If a captive owner continually files small claims without addressing the underlying issues, they may face increasing premiums or even be asked to leave the captive.
The Consequence of Sever Claims
More severe claims pose a different kind of risk. If a captive owner experiences multiple large losses, the captive may have to increase their reinsurance costs, which can be reflected in higher premiums.
How is Surplus Distributed in a Captive Insurer?
Surplus distribution is one of the most attractive features for captive owners. Here’s how it works:
The Timing of Surplus Distributions
In captive insurance, surplus funds are usually distributed a few years after the policy has ended. This delay allows for the accounting of any incurred but not reported (IBNR) losses. For example, a portion of the surplus from the first policy year might not be distributed until year five. Additional distributions will be seen in subsequent years.
The staggered distribution helps make sure the captive remains financially stable.
The Role of Captive Efficiency
The efficiency of the captive plays a significant role in how surplus is distributed. If the captive is well-managed and claims are kept low, more surplus can be distributed back to captive owners. That said, inefficiencies or higher claims can reduce the amount of surplus available.
How Do Captive Insurers Remain Profitable?
Here’s how captives remain profitable and how it impacts captive owners:
Monitoring Claims Frequency
One key indicator of a captive’s efficiency is the frequency and severity of claims. Captive Managers will closely monitor these metrics to ensure the loss fund is sufficient and that premiums are used effectively. Captive owners can contribute to the captive’s profitability by focusing on risk management and claims prevention.
Risk Sharing Is Important In a Group Captive
If one member in a group captive experiences a significant loss, the cost is spread across all members. This can lead to increases in premiums for all participants. Captive owners need robust safety and risk management programs to minimize risk and avoid contributing to collective losses.
Are Captive Insurers Right for Your Best Clients?
Compared to the traditional market, captive insurers are transparent as to where every dollar of their premium is going. Not only that, but they offer benefits to your clients, such as underwriting profits and robust risk management programs to reduce claims and provide benefits that can be maximized.
With this said, captives don’t work for every business. That’s why you need to read about the financial advantages and disadvantages of captive insurers. Make sure to weigh the pros and cons to see if captives are the best choice for clients.
If you have more questions about captives or need a consultation, schedule a call with Captive Coalition to talk to one of our insurance advisors.
