The Pluses and Minuses of Captive Insurance

09/12/2019 Written by: Rocky Roemer

As insurance premiums rise and underwriters are ever more assiduous in evaluating risk, insurance buyers find themselves more open to ‘alternative risk’ or ‘captive’ insurance options. Captives may at first seem complex and difficult to administer but understanding a few basic principles can help uninitiated buyers (and insurance brokers) decide if a captive is the way to go. One consideration always to keep in mind when evaluating a risk for alternative risk financing is this: captives are not for everybody. This area calls for a bit of specialized expertise so that the agent is positioned to advise his client of the pluses and the minuses.
There has certainly been significant migration of traditional risk into captive facilities in recent decades. Hard markets tend to accelerate this trend. But the prudent risk manager will always keep in mind that simply evaluating a risk for inclusion in the alternative risk marketplace does not magically transform it into a superior risk. And for the most part, it is the above-average risk that will best qualify for -- and benefit from – a captive solution.
A captive risk financing option is nothing more than an alternate method of financing risk that pays the claims of its owner/policyholder and provides the potential for net cost savings. A captive does not fundamentally change the nature of any risk nor does it reduce or eliminate exposure to loss. Captives are financing mechanisms that may provide economic benefits and net cost/tax savings. But it must be kept in mind that the initial costs of a captive are nearly always higher than traditional insurance and the buyer should regard this option as a medium-to-long-term solution. The insurance buyer must be committed to the investment of significant resources in order to produce an eventual ROI; typically, on a 3-5 year horizon.
Nonetheless, there are numerous significant financial as well as non-economic advantages to captives -- for the right risk. Being in a captive removes the buyer from the tedious repetitive insurance-buying process and also tends to moderate some market swings. Additionally, captives allow for the insurance buyer to assert more control over the provision of legal, claims, loss adjustment and loss control aspects of their risk financing mechanism.
As a captive insurance option is being considered, the prudent insurance counselor and insurance buyer will keep in mind the minuses of captive insurance. Notably: higher initial costs, no guaranteed net savings and greater burden of administration along with the potential pluses: possible lower overall costs, greater control, reduction of rate fluctuations. 
Captive insurance is an increasingly popular method for financing your risk. When a buyer has a knowledgeable insurance counselor and the correct risk profile, choosing a captive can be a the winning decision.

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