The advantage to a Captive Insurance model
Workers’ compensation insurance is a major expense for companies. As an alternative to a traditional insurance model, some businesses are choosing a captive insurance model – one that works outside of the commercial market and aims to achieve financial gains as well as mitigate risk. In this article, we take a look at how a captive insurance model differs from a more traditional insurance policy and the potential benefits for such an insurance structure.
How a Captive Insurance Model Differs
In a traditional workers’ compensation insurance model, premiums are assessed by generalized industry averages and state rates, and then paid into an insurance company to provide risk protection. Once those premiums are paid, they are assets of the insurance company. Any profits realized from investments, reduced operating costs, or lower claims costs return to the insurance company.
Within a group captive insurance model, funds paid in are wholly owned and controlled by the group members, meaning that any profits from strategic investing, accrued interest, or unused losses returns to the insured captive group members. Premiums remain under the control of the group members. Additionally, with premiums based on a company’s lived experience over the last five years, there is greater individualization of risk management.
The funding of a captive model comprises two categories – the forecasted loss and the operational costs. The total of the two figures is the captive member pay-in and is typically lower than traditional insurance premiums. Operating costs are generally lower with a captive model as only good risks are accepted and there is also insulation from variable market conditions.
While individualization and lower premiums is always an insurance benefit, the key difference between a traditional and a captive insurance model is who gains from the profits derived from investment and interest of premium funds and unused loss funds. In a traditional model, the insurance company profits; in a captive model, the group members profit.
Why Join a Captive?
Because it is a major expense, many businesses seek to mitigate the cost of workers’ compensation insurance while still protecting themselves against detrimental events. With a captive insurance model, a potential benefit is greater control over coverage, especially in instances where commercial insurance companies may be unwilling or unable to provide coverage for various risks. In most cases, an individual company understands their personalized risk better than the general market. With an insurance captive offering insulation from market conditions, a company also has greater control of their risk and their risk financing to protect themselves appropriately. Additionally, with greater control, companies have more autonomy when it comes to loss prevention and claims management. This contributes to probable cost reduction. Combining the potential for financial growth through investment and interest with operational costs reduction results in financial gains.
Criteria of a Good Captive Fit
What factors go into considering whether or not a potential group captive is a good fit for a company? First off, excellent practices in claims handling and safety are paramount. Premiums are based on lived experience and a strong record is necessary to be profitable. Secondly, it is important that owners be highly involved in the business and have strong relationships with other captive partners. A basis of trust as well as a commitment to maintain the captive partnership contributes to success. Finally, forward-thinking ownership and a willingness to bet on themselves is imperative for a financially successful captive insurance group.
In considering joining a captive, it is important to note two different membership compositions – heterogenous and homogenous. Either structure can work well for a company as they operate in the same manner and both serve the same objective of more control over insurance costs. The difference is that in a heterogeneous group captive, members combine from diverse industries. With membership ranging from fields as varied as construction and manufacturing, retail, automotive, and others, there is greater risk diversification, meaning that loss exposure is spread out. Conversely, a homogeneous group captive is composed of members from within the same industry. Because its members have similar insurance and risk management needs, coverage can be catered to the specific industry, however loss exposure may be more concentrated. Again, either structure can work well for a company as long as it aligns with the business’s insurance needs.
Summary
So while a captive insurance model resembles a typical insurance model in many ways, the primary difference of who controls and benefits from premium capital is key. We’ve focussed on workers’ compensation captive models in this article, but note that captives can also be beneficial for general liability and automotive insurance coverage. Regardless of coverage needs, for those companies interested in managing and financing their own risk, a captive model may be a financially beneficial insurance option.
