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Hard Market & Captives: Why it Makes Sense

In the face of increasing deductibles and rising premiums, captive insurance might just be the ideal solution. Companies struggling against an increasingly hard market may find captive insurance a feasible alternative to traditional insurance.

The hard state of the current insurance market poses many challenges and obstacles, including skyrocketing rates, reduced capacity, and more restrictive terms. To be sure, many of these conditions have existed since 2020. Even so, businesses have had to find creative ways to deal with these increased financial burdens.

The current state of the market results from many factors, including low interest rates that adversely affected investment returns and large claims stemming from recent natural disasters. These have driven commercial insurers to raise premiums, reduce capacities, and abandon certain business lines, thereby limiting insurance options. Consequently, policies that previously provided $1 million in coverage may now cover only $500,000.

Unfortunately, the market isn’t likely to improve any time soon. Paul Horgan of Zurich North America predicts that the hard market trend will continue through 2022 in some sectors. In order to weather the storm, business owners should consider setting up a captive insurance firm.

The basics of captive insurance

Captive insurance services are provided by “captives,” which are essentially insurance firms owned and operated by the parent firms they insure. These organizations are typically managed by larger insurance firms or “fronting companies” that provide financial and administrative services.

Captives are often feasible alternatives to standard insurers because of the way they are set up. With captives, the parent firm typically pays premiums to the fronting company. These payments are then sent to the captive insurer to cover future claims.

Captive insurance is especially helpful in a hard market when businesses assume more risks due to higher deductibles. Because they have to pay more to get the same amount of insurance coverage, assuming the risks themselves via a captive is often a more cost-effective option.

Working with a captive will continue to pay off long after the market settles. It also provides many long-term benefits and considerably more value than a quick-fix solution to a hard market.

The financial benefits of captive insurance

The financial benefits alone are a good reason to go with captive insurance. With a traditional insurer, a company that purchases $1 million worth of insurance with a $250,000 deductible may have to pay $750,000 in total premiums. This means they will have to pay out-of-pocket for the first $250,000 in claims in addition to the premiums it has to pay.

If the same company forms a captive instead, it will get the same coverage, and $250,000 is set aside for potential claims. But while this arrangement entails a higher insurance expense upfront, the $250 k will go directly to the captive. If the company incurs losses less than that amount, the money remains with the captive and can be added to the coverage for the following year. Furthermore, the funds can be used to offset other company losses, particularly those difficult to insure.

Captive insurance: a flexible and focused solution

Captive insurance is more than just about cost savings. Although they provide many cost advantages, their true value is offering flexible and focused solutions. Going by the same scenario described above, parent firms benefit from a captive solution worth $250 k instead of having a deductible for the same amount.

But while the parent company still has to come up with the funding up front, its captive assumes responsibility for all future claims. Therefore, parent firms are essentially investing in their own cash flow management and investment returns, ultimately resulting in a stronger business. They also have more control over deductible and coverage limits, defining these according to the company’s needs.

Why not both?

Captive insurance isn’t necessarily an ‘either-or’ solution. Many companies have found that a combination of traditional and captive insurance provides the most flexibility and more comprehensive coverage. By utilizing both solutions, businesses have the advantage of the general coverage standard insurance provides while benefiting from the more focused and personalized protection afforded by captive insurance.

Captive insurance strengthens risk management

Setting up a captive insurance firm can help strengthen a business’s risk management capabilities. A company responsible for its losses tends to be better focused and more effective at risk management. Consequently, they become stronger and more resilient to market conditions. This ultimately benefits the firm and improves its ability to overcome challenges and obstacles.

About Caitlin Morgan Captive Services

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.