Why has captive insurance become an emerging coverage platform of choice for organizations seeking to improve or augment their risk management programs?
While there are no simple answers to this question, the most insightful responses on explaining the growing popularity of captive insurance programs focus on the fact that captives afford companies with opportunities to strengthen their overall insurance coverage and to minimize potential exposures. Captives also provide companies with increased control over insurance assets and their risk management strategies.
In reality, captive platforms should be considered as more of a coordinated business strategy than simply as an insurance vehicle. Over 75 percent of Fortune 500 companies now utilize some form of captive insurance. Meanwhile, the number of captive insurance entities is growing exponentially worldwide. Today, between 7,500 to 10,000 businesses in the world employ some form of captive insurance coverage. Those totals are expected to triple over the next 10 years as more companies further examine comprehensive and well-targeted risk management plans.
Advantages of Utilizing Captive Insurance Platforms
By definition, a captive insurance company, or CIC, is an insurance company that is owned by a business, business owner or related parties. The purpose of the CIC is to sell various types of insurance policies primarily (though not exclusively) to other operating businesses that are owned or controlled by the company’s ownership. Captive insurance companies must be licensed to sell insurance by an appropriate jurisdiction, or domicile, such as captive-friendly states like Tennessee and South Carolina or offshore locations like the Cayman Islands. CICs are owned by the same economic interests that own the operating insured business, and captives can be an alternative to self-insurance.
As the demand rises in the overall self-insurance market, companies will have more opportunities to consider captive insurance policy options. While captive insurance is similar to self-insurance, captives employ the use of a separate legal entity established as a licensed insurance company.
Like self-insurance, captives are designed to insure the risks of the captive owner and its affiliated businesses. Unlike self-insurance where losses are expensed as paid (which can take months or years depending on the type of risk), premiums paid to a captive can be taken as a tax deduction immediately. One of the most attractive aspects of a captive plan versus self-insurance and other traditional business policies is that the owners of the captive reap the benefits of favorable claims experience and investment earnings that would otherwise go to commercial insurance companies.
Top Three Advantages of Captive Platforms
While there is a sizeable list of advantages for establishing captives, the top three reasons companies should consider captives are the following:
- Asset retention
- Covering risks that are difficult or expensive through traditional insurance
- Increased control over insurance program and risk management strategy
Noting Tax Advantages
While the tax advantages from captive arrangements should never be at the top of any company’s list, captives can offer accelerated premium deductions as opposed to self-insurance programs. However, if the IRS believes that a captive has been established purely for tax purposes, the agency may challenge captive status of the company, so comprehensive documentation of the objectives of the captive structure is important.
Many of today’s traditional insurance offerings feature exclusions and limitations that are unattractive, and companies are unable to adapt these policies because they are part of a commercial insurance pool.
A captive plan can allow a company the ability to tailor its policy to address a specific coverage need.
In addition to serving as a substitute for commercial liability risk insurance, for instance, captive plans can be used by companies to cover the cost of deductible payments or losses in excess of insurance limits. Because these policies have the ability to be adapted to specific needs, captives are the ideal vehicle to cover risks that are currently uninsured.
In many situations with captives, businesses are looking for coverage for low-frequency yet high-severity risks such as cyber attacks, business interruptions, a loss from an act of terrorism, or loss of a major customer. Typically, those would be losses that businesses would have to absorb.
Looking specifically at healthcare entities, professional liability and worker’s compensation are the most prominent mainstream areas covered by commercial insurance policies that could be replaced or augmented by captive coverage. Captives offer organizations numerous coverage opportunities, particularly with non-traditional risks.
Companies with captive platforms and strong risk prevention programs can reap the benefits of minimizing claims. By reducing claims, the premiums become a further investment in the business. The money paid into the captive would still be there when the business owner needed it, and those funds could be accessed in the future through a proper exit strategy or distribution arrangement.
Is a Captive Right for Your Business?
While captive insurance programs offer a host of advantages, these programs require a significant financial commitment over a sustained period of time. As a result, captive insurance is not a viable option for all businesses. Companies considering the startup of a captive should ask if they meet a few qualifying financial parameters to be an ideal candidate and then also weigh the benefits, as well as the costs, to determine feasibility.
Qualifying Financial Parameters
Consider two main questions:
- Does the company pay at least $300,000 in insurance premiums annually?
- Is the company’s annual revenue consistently $10 million or more?
Organizations examining captive insurance programs typically look at two key financial metrics – annual business insurance premiums and overall annual facilitation cost for the captive. While there are some variances depending on industry, a good candidate for a captive insurance platform is a company that typically pays in the neighborhood of $300,000 in premiums per year for its current commercial coverage. In addition to premiums, a company utilizing a captive will also have to be prepared to cover claims administration fees, actuary fees, management fees and audit fees.
A company’s annual revenue is just as important as the cost of annual premiums paid. Candidates for captive insurance plans are companies that have annual revenues of $10 million or more. Companies with less than $10 million in annual revenue and less than $300,000 in annual premiums may want to wait to consider the viability of a captive.
Captive programs typically perform best for companies in industries with consistent earnings and strong cash flows. Companies cannot get into a situation from one year to the next where they are unable to pay the premiums. The cash flow has to be on hand in order to effectively operate a captive, and the cash has to be there over the long haul.
Consider typical costs:
Companies will need to budget for start-up costs related to the captive and they will have to account for annual expenses related to the operation of the captive. No matter how big or small the captive, the company is going to have a minimum cost in annual captive insurance costs. A captive insurance feasibility study can determine the amount of a given company’s annual costs. In looking at first-time start-up expenses for captives, businesses can expect $80,000 to $90,000 in start-up costs and legal fees. Once the captive is established, the business will need a third-party administrator (TPA), a captive management company, an actuary and an independent auditor. The fees for the TPA could be very high or very low – depending on the frequency and the types of claims involved.
Offshore Vs. Domestic Captive Programs
According to a recent study, captive insurance programs that are based in offshore locations comprise nearly 35 percent of all existing captive programs, with the Cayman Islands hosting just over 15 percent of those accounts.
The Cayman Islands were essentially praised in a U.S. Government Accountability office report that made the following observation: “The factors that attract U.S.-related financial activity to the Cayman Islands include its reputation for stability and compliance with international standards, its business-friendly regulatory environment and its prominence as an international financial center.”
Thanks in part to its tax policy, the captive insurance industry in the Cayman Islands is one of the more mature markets in the world. Yet, considering 80 percent of the world’s offshore hedge funds are now domiciled in the Caymans as well as the country’s broad financial services base, some insurance industry observers believe the Cayman captive market will eventually become No. 1 in the world.
Getting Your Captive Started: We Can Help!
Ultimately, companies must examine all the facts when considering establishing any captive insurance program. Companies that meet the annual revenue and premium expenditure thresholds should ask the following question: Why should your company pay more for insurance coverage when a captive may reduce your overall costs? A simpler way to ask the same question is this: Does your company want to keep more of the money it has earned?
Is your company a candidate for developing a captive insurance program? Elliott Davis Decosimo has assembled a strong team of experienced professionals who can evaluate if your company would benefit from a captive insurance strategy. Elliott Davis Decosimo can help your company initiate a feasibility study, find the right third-party management group and walk you through every step of building a strong captive insurance program for your business. Whether it’s an offshore or domestic captive program, Elliott Davis Decosimo can help your company find the best fit for your coverage needs. Elliott Davis Decosimo invites your company to contact our firm today about assessing captive insurance options for your business.