While not every hostage uses a captive manager, the vast majority of them do. A captive manager is crucial to the captive’s formation, development, and overall success. Accounting, actuarial, claims management, domiciliary and regulatory, investment management, pricing and underwriting, and maybe tax are all areas of knowledge that a captive manager can bring to the table. While the captive manager may not be an expert in all of these areas, it does have vendor networks in each of them that can help your company find the suitable professional partners.
- Scale vs. local knowledgelocal knowledge may be more necessary if the business will only function in one state. A larger-sized corporation may be the best option for captives operating on a national or international scale.
- Capacitydoes the firm have the talent to handle the additional effort that comes with adding your captive to the mix?
- What is the firm’s reputation like? When conducting a reference check, are you able to speak with both current and former clients?
- Domiciliary knowledgeunderstanding local legislation and tax difficulties is critical to the captive’s success.
- What are the costs of running your captive, and what is included in those costs? How will work that isn’t covered by the fee schedule be billed?
Many captive managers have the knowledge and experience necessary to conduct captive feasibility assessments. So hiring a captive manager on a stand-alone basis to do the captive feasibility study is one approach to get to know them. If you decide to go this way, make sure you keep the rights to the captive feasibility study so you may switch captive managers if you need or want to.
How do I set up a captive insurer?
The great majority of Fortune 500 corporations utilize captives to finance their own risk. In
In fact, there are almost 7,000 captive insurance businesses based in the United States.
There are more than 70 regulatory jurisdictions in the world.
A captive insurance business is a type of insurance firm that is set up to insure the risks of its owners.
of a sound risk management strategy A captive insurance company, to be precise.
is it “an insurance company that is entirely owned and governed by the people who pay the premiums; its principal mission is to protect the people who pay the premiums.
The captive’s objective is to guarantee the risks of its owners, and the captive’s insureds gain from it.
Profits from underwriting by insurers” This covers pure prisoners, associate captives, and other types of hostages.
Captive insurance for the industrial sector.
In the five-step primer on setting up a captive insurance company, learn about the main procedures required to successfully establish a captive insurance company.
Why do firms form captive insurers?
A captive insurance firm is a wholly-owned subsidiary insurer that manages risk for its parent company or a group of connected enterprises. If the parent company cannot find a suitable outside firm to insure them against specific business risks, if the premiums paid to the captive insurer result in tax savings, if the insurance provided is more affordable, or if it provides better coverage for the parent company’s risks, a captive insurance company may be formed.
How do you form a captive?
In general, the following stages are involved in founding a captive insurance company in Tennessee:
- To discuss the proposed captive insurance company and get early feedback from the Department, call or email the Director of Captive Insurance or employees.
- Prepare the documentation required for the creation of a corporation. Submit your formation documentation to the Department for Commissioner approval. Present the documents to the Secretary of State, along with the relevant fees and the Commissioner’s permission letter, once they have been approved by the Commissioner. Obtain a copy of the formation certification to submit with your application to the Department once it has been filed with the Secretary of State.
- Schedule a face-to-face meeting between the captive owner(s) and the Captive Section at our Nashville headquarters, 500 James Robertson Parkway.
- If the Commissioner deems it essential, application materials may be assigned to an independent review firm.
- A Certificate of Authority Issuance fee of $440.00 is due once your application has been approved by the Department.
Please see Licensing Information and Rules and Laws for more information on the captive formation procedure.
- Choose a captive management firm, an actuary firm, and a CPA business in Tennessee.
- Your captive manager must complete the Captive Manager Designation Form for Captive Insurance Companies if they are not already designated as a service provider in Tennessee.
How does a captive insurance company make money?
Because of the numerous economic and noneconomic benefits that can be obtained via its use, captive insurance is the most common form1of alternative risk financing. The following are some of the advantages of captive insurance over commercial insurance:
- Costs are stabilized because captives aren’t subjected to the underwriting cycle. As a result, possible premium changes from year to year will be unaffected by commercial rate changes in an insurance company’s book of business. Rather, premium adjustments will be based on the captive’s loss history. Premiums paid into the captive will be consistent assuming stable loss experience.
- Earn investment income: Captives can profit from their loss and unearned premium reserves by investing them. A commercial insurer’s guaranteed cost insurance would not give the policyholder with this additional money.
- Capture underwriting profits: If the premium paid into the captive is larger than the loss and expense expenses that the captive will eventually incur, the captive will be allowed to keep the underwriting profits. These underwriting earnings might be returned to the parent as a dividend or used to assist increase capital and surplus. On this excess capital and surplus, a captive can make investment income. If the parent had purchased a guaranteed cost policy, these profits would not have been realized.
- Provide coverage that isn’t available on the market: Some coverages have exorbitant prices, making them virtually unaffordable on the open market. When possible, a captive can provide these coverages at a premium based on the insured’s loss experience. A captive can also provide coverage for unusual risks that aren’t covered by standard insurers.
- Improved claims handling and risk management: A captive gives for more control over the claims handling process in some scenarios. Potentially big claims can be detected and managed early on to save money, as claims losses tend to rise the longer they remain open and unresolved. 2
- Potential federal tax benefit: For federal tax purposes, a captive may be able to deduct both loss payments and reserve estimates, whereas self-insurance only allows for deductions as losses are paid. Because of the faster timing of deductions, investment income can be gained on the taxes that were previously avoided. These savings can be significant for large captives and captives that write long-tailed coverages, especially in a high-interest rate environment.
- Capturing the complete cost of risk: While self-insurance can provide many of the benefits listed above, a captive is an effective risk management tool for measuring the total cost of risk. The primary reason why parent firms employ a captive, according to a survey of parent companies in the Marsh 2020 Captive Landscape Report, is to operate as a formal funding vehicle to insure risks that the parent has elected to self-insure. 3 The costs of self-insuring with a captive can be easily traced through the captive’s financial accounts.
Captive insurance is used by nearly all Fortune 500 corporations and many midsized businesses for these reasons, among others. 4 Single parent captives, which insure the risks of a single company (the parent), are the most common type of captive. In 2019, single parent captives accounted for over 80% of the captive market’s gross written premium. 5
Despite the fact that captives are set up for different reasons than other types of insurance, we were curious if single parent captive insurers make more money than other types of insurance. To see if single parent captive insurers are more profitable than other types of insurance, we looked at financial statement data from over 60 single parent captives over the last five years (2016-2020), as well as annual statement data from S&P Global Market Intelligence for traditional commercial insurance companies and risk retention groups (RRGs), a more regulated form of captive insurance. Any reference to “captives” in the rest of this article refers to single parent captives. RRGs are a type of group captive that insures the risks of many enterprises. Group captives have various aims, objectives, and rewards.
We looked at a variety of financial measures that can be simply calculated from insurers’ balance sheets and income statements. We didn’t make any adjustments for accounting biases and merely used the numbers as is. The data for traditional insurers and RRGs is obtained from the aggregate of the top 100 for each firm type (using calendar year 2020 net earned premium).
The combined ratio is likely the greatest indicator to use when assessing profitability. Using the income statement, we estimated combined ratios as the ratio of experienced losses, incurred loss adjustment costs (LAE), and underwriting expenses to earned premium. Figure 1 depicts the historical combined ratios for each insurance business over the previous five years.
Figure 1: Combined Ratios 2016 to 2020 by Company Type
Traditional insurers and RRGs both have higher combined ratios than captives. The combined ratios of traditional insurers and RRGs are hovering around the breakeven point of 100 percent. The RRG combined ratios are somewhat higher than 100% in 2019 and 2020. Captives, on the other hand, have a five-year average of 83 percent. Because the total ratio is 100 percent less than the percentage of premium gained as underwriting profit (ignoring investment income), captives are profiting roughly 20% of premium! These gains can be utilized to boost surplus, which can serve as a safety net in the event of a loss. They can also be utilized to pay the parent a dividend.
While looking at previous combined ratios can provide insight into a captive insurer’s profitability, we went deeper into these profit disparities. An insurer’s premium is the sum of three items in a simplified world: expected future expenses, projected future losses, and a profit and contingency provision. Expenses are the first component of premium that we analyzed amongst company kinds. The ratio of current year underwriting expenses to current earned premium was used to construct historical expense ratios. The graph in Figure 2 shows the historical expense ratios for each type of firm over the last five calendar years.
Figure 2: Underwriting Expense Ratios 2016 to 2020 by Company Type
Over the last five years, captive underwriting expenditure ratios have averaged roughly 9%, compared to around 31% for traditional insurers and 21% for RRGs. The overhead costs of captives are minimal to non-existent. They usually lack specialized personnel and office space. A third-party administrator (TPA) often handles claims, whereas an actuarial business handles actuarial services. Some captives may also route a portion of their expenses through their parent business rather than the captive, which could explain the lower ratios. Traditional insurers have additional costs, such as agency commissions, in addition to paying for staff and corporate office space.
When comparing traditional insurers to RRGs, RRGs often have a smaller staff, resulting in lower overhead costs. The disparity in expense ratios between traditional insurers and RRGs is also due to commission and brokerage expenses. The average ratio of net commission and brokerage fees to earned premium for traditional insurers from 2016 to 2020 is 13 percent, compared to 0.5 percent for RRGs. The difference in commissions is fairly significant because many RRGs had zero net commission and brokerage fees.
Premium taxes are another cost consideration. Captive insurance companies pay lower premium tax rates than typical insurance companies. Furthermore, compared to the percentage of premium charged in most other states, other states, such as Arizona and Utah, simply charge a minimal yearly cost. There is no benefit to RRGs because they are subject to the same premium taxes as traditional insurers6.
Not all captives, however, have lower expense ratios. Our 60 captives were divided into three categories based on premium volume. Small captives, defined as those with annual premium volume of less than $1 million, have a five-year annual average expenditure ratio of 42 percent. Medium-sized captives, with annual premium volumes ranging from $1 million to $10 million, have expenditure ratios that are closer to RRGs, with a five-year average of 17%. Large captives, defined as those with an annual premium volume of more than $10 million, benefit from economies of scale, with an average expense ratio of 8%. These huge captives, which account for the bulk of the captives surveyed, are the principal driver of the low expense ratios seen in Figure 2. Some of the world’s largest captives have expense ratios of less than half a percent. Figure 3 shows the expense ratios and percentages of captives surveyed by year and size in a table.
Figure 3: Captive Expense Ratios 2016 to 2020 by Captive Size Band
Because captives’ historical expense ratios are much lower than those of other firm kinds, the variations in combined ratios in Figure 1 must be due to decreased expenses, right? Not so quickly! Let’s take a closer look at captive spending. Returning to our simple premium example, expenses are relatively predictable when compared to loss and LAE projections. Captives have expenses for captive management, actuarial, audit, legal, and board meetings, among other things. These costs are mostly set and may be forecasted easily in the future. Premium taxes are the only variable cost that captives have, and they are highly predictable because they are simply added to the overall premium. Captives will generally know what their expenses will be when predicting premiums, and will price these expenses into their policies accordingly. Commercial insurers and RRGs, on the other hand, can usually forecast the expense component of their premiums with a high degree of precision.
As a result, the greater premium base must be the driving force behind the reduced expenditure ratios, rather than the expenses themselves. To gain a better understanding of the premium’s components, let’s continue our investigation.
The loss and LAE were the following aspects of premium that we looked into. The loss and LAE ratios were derived using the income statement’s current year incurred losses and LAE to earned premium ratios. These historical loss and LAE ratios for each type of company are shown in Figure 4 as a graph per year.
Is captive insurance a good idea?
. Despite the fact that their execution and legal framework are frequently misunderstood, the financial benefits might be highly appealing. Captive insurance, according to some experts, is the best thing since sliced bread. Others are hesitant to involve their clients in the creation of a prisoner, knowing that the IRS closely monitors them. This article explains what captive insurance is and why the Internal Revenue Service frequently disputes it, as well as why, when done right, captive insurance can be a valuable instrument. The post also explains how to set up and run a captive to avoid IRS penalties.
What are the two major types of captive insurance companies?
In a recent post on the Risk Matters blog, I discussed captive insurance, which is defined as an insurance company owned and controlled by insureds that insures the risks of its owners in exchange for a share of the captive insurer’s underwriting earnings. Businesses seeking better control over claims management, expert partners, risk stability and reduction, and, ultimately, a return on underwriting profits and investment income are increasingly pursuing this alternative.
Ask yourself the seven questions in my previous blog post if you’re not sure if a captive insurance company is good for your organization. If you responded “yes” to the most of them, it would be worthwhile for your company to look into this insurance option.
Captive insurance firms come in a variety of shapes and sizes. Single-parent hostages and group captives are the most common forms.
A single-parent captive, also known as a pure captive, is founded as a subsidiary of one company and is owned and controlled by that company. The captive insures the company and its other divisions. Captives with only one parent have the most flexibility, but they also have the highest formation costs. This captive is often used by large, financially secure enterprises that want complete control over their insurance program while also earning investment income on premiums paid into their own insurance company. Single-parent business owners typically commit several million dollars in premiums and, ideally, have seven or more subsidiary businesses in the program.
A sponsored captive, also known as a group captive, is an insurance firm owned and operated by unrelated entities. It’s a collection of businesses that have banded together to take control of their own insurance future through an alternative to standard insurance.
Premiums for group captive owners will range from $400,000 to $1,500,000. Other loss-sensitive solutions are frequently more cost-effective outside of this range. Member companies are often entrepreneurial in spirit, with a strong safety culture and a good loss history. Workers’ compensation, commercial general liability, and automobile liability/physical damage are typically covered by group captives.
Insureds can insure or self-insure risk in a variety of ways, including captives. It’s crucial to pick the correct risk-financing option. However, the safety, contractual risk transfer, and claims management of any program are significantly more important than the insurance framework. Equal consideration should be given to these areas when assessing captive options, as well as whether the captive program and team of service providers will have a good impact on these aspects of your organization.
What are the disadvantages of captive insurance?
Because the company is effectively self-insured, it will need to raise a large sum of money to maintain in reserve in case of a claim. If the entity undervalues its need for protection or suffers a catastrophic loss, it may not have enough cash on hand to provide effective protection. If the corporation is forced to use other assets, this could have a significant negative impact on its bottom line.
Is captive insurance legal?
For small-business owners, captive insurance is a legal tax arrangement. Premiums paid to a captive insurer can be deducted from your taxes if the arrangement meets specific risk-distribution criteria. As a result, even though losses may never arise, the company receives a current-year write-off. The Internal Revenue Service (IRS) has established the rules under which captive insurance qualifies as insurance for federal income tax purposes and premiums are deductible in Rev. Rul. 2002-89 and Rev. Rul. 2002-90. Captive insurance is considered as legitimate insurance (i.e., premiums are deductible) under two safe harbors:
How do captives work?
The captive insures the owner or its affiliates against risks that the owner wants to keep, and the insured entities pay the captive a premium. A captive’s profits are kept within the parent company’s group rather than being “lost” to the insurance market.