The insurance industry has experienced tremendous growth and change over the past century. One of the most profound developments in that time was the captive insurance model, which has transformed business insurance coverage options. Since this model was first developed, captive insurance has been adopted by business interests of every size and type. In this guide, we will explore some of the most frequently-asked questions (FAQs) about captives, helping you to provide your clients with the information they need to make important decisions about their insurance options.
Captive insurance is a self insurance solution created by forming a formalized insurance entity on behalf of a parent company, organization, or group of related businesses designed solely to insure the risks of the parent. By self insuring risks through alternative risk financing, companies can gain better control over their coverages, insurance management, and premium expenses.
Captive insurance offers business owners several advantages. These include:
Captive insurance can take several forms, each designed for a specific application. The most basic of captives is the single-parent model – sometimes referred to as a “pure captive” — where the self insurance entity is established to provide coverage for one parent company. Typically, single parent captives are used by larger corporations able to finance the creation of the captive. Other captive types include:
Group Captives – formation of a captive by a group of individuals or business entities in joint ownership of the insurance company. Within group captives are homogenous groups, which cover insureds in the same or similar businesses, or heterogenous groups consisting of insureds from different industries. Group captives are often used by midsize and smaller business owners that may not be able to afford ownership or establishment of their own captive.
Protected Cell Captives – this type of captive is established by a single or group sponsoring entity. Then, it sells or rents individual “cells’ to smaller business owners. The parent handles administration and claims. There is no risk-pooling in a protected cell captive (PCC); each owner’s or renter’s assets and liabilities are shielded from other cells.
Risk Retention Groups – like a group captive, a risk retention group (RRG) is owned by businesses with similar insurance needs. Risks are pooled in these groups. All insureds of an RRG must be owners, and all owners of the RRG must receive insurance coverage from the group. Unlike regular group captives, RRGs are domiciled in one state but may do business in any state after completing a registration process with that state’s insurance commissioner.
Forming any new business entity involves expenses, and captive insurance entities are no exception. The costs to form a captive can be prohibitive to smaller operations; before the development of groups, PCCs, and RRGs, captives were reserved only for the largest corporations. Typically, the establishment of a smaller captive can require start-up costs in excess of $50,000 and may require annual fixed overhead costs of $30,000 or more. The more complex the captive, the higher the potential for costly start-up and overhead costs.
As with any business venture, starting a captive comes with certain risks. The largest of these risks is in management and administration of the captive itself. Captives require specialized skills to establish and to manage, including claims processing, risk analysis, and tax expertise. For smaller firms without these skills or management experience, third-party captive service providers can provide the management support needed.
Another risk is centered on regulatory concerns. Captives must be formed to provide insurance for its parent or group. Unfortunately, companies have used the formation of captives solely as a tax shelter, bringing scrutiny from the Internal Revenue Service and other agencies.
Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.