While conventional insurance continues to be a common form of risk financing, an increasing number of companies are seeking alternative solutions. The most common alternatives are protected self-insurance and captive insurance companies.

Protected self-insurance is an alternative selected by many Fortune 100 organizations. It requires an extensive qualification process in each state in which the company has exposure to loss. Protected self-insurance is not always feasible or desirable for a mid-sized corporation.

Another newly emerging alternative risk management program is the formation of a group captive insurance company. This alternative is well suited for a mid-sized corporation desiring to take control of its insurance program.

Definition, types of captive insurers

A group captive insurance company is a separate corporation, owned and controlled by its members, formed primarily to insure the risk of its noninsurance members.

A group captive can be developed to address the specific needs of the group’s risk and exposure profiles.

There are two basic types of group captives. Both types are directly related to the degree of continuity in operations of the captive’s respective membership.

A group captive insurance company is heterogeneous when it is owned by and insures a group of unrelated companies representing diverse industries. A heterogeneous captive encourages strong growth by removing the concern that competitors will share the captive advantage.

In contrast, a homogeneous captive is a company owned by a number of companies in the same industry or association, with similar insurance needs. A homogeneous captive may also be called an association or industry captive.

Member profile, captive coverage

There are several qualities risk management companies typically seek in qualifying a prospective member for admittance into a captive insurance company.

Specifically, these attributes are:

• Entrepreneurial spirit;
• Financial stability;
• Better-than-average loss experience;
• Low (or descending) workers’ compensation modification factor;
• A strong safety program;
• Combined premiums (workers’ compensation, general liability, automobile liability); and
• Automobile physical damage totaling between $100,000 and $2 million.

Coverage provided by a captive can include the following (among others):

• Workers’ compensation;
• General liability;
• Automobile liability (including non-owned and hired); and
• Property (options may include windstorm, flood, and quake).

Whither captives?

Captives are domiciled, or incorporated, on-shore or offshore.

An on-shore captive is incorporated and managed within the United States. An offshore captive is incorporated and managed outside of the United States.

The selection of a domicile is based on the unique needs of each group captive. Considerations such as capitalization requirements, tax implications, cost of incorporation and management, and limitations on the placement of coverage are reviewed with the attorney and tax accountant hired by the group captive.

This article was written by Gallagher Captive Services, a subsidiary of Arthur J. Gallager & Co., a broker that offers a spectrum of risk management services. Contact the company at 630-773-3800.

Sidebar: Captive insurance questions and answers

What is a captive?

This insurance company is owned and controlled by its shareholders/ insureds. Coverages provided by a captive can include workers’ compensation; general liability; and automobile liability.

What do I gain by belonging to a captive?

Increased control over your insurance costs. Participate in:

• A risk-management program designed to meet the specific needs of the captive’s members;
• The selection of service providers;
• The claims management process.

Reduced costs. Contributions are based on your company’s expected losses (plus fixed costs); are likely to be more stable from year to year; and allow you the ability to retain investment earnings.

What will it cost me to participate?

As an owner in the captive, each member will pay for and receive one share of restricted ownership stock* in the incorporated captive, in addition to a one-time charge to cover incorporation expenses.

Beyond this, each member will make an annual contribution sufficient to cover the cost of the member’s projected losses plus a pro-rata share of the captive’s administrative expenses.

Investment may vary according to terms of the captive’s incorporation agreement ($36,000 minimum investment).

How do fixed costs differ for captives vs. conventional insurance?

At inception, fixed costs for a captive are approximately 5% less than that for conventional insurance. Over time, fixed costs for a captive can further shrink to represent as little as 25% of the total captive insurance dollar. The net fixed cost of a mature captive can represent as little as 15% of total insurance costs vs. 40% typically found in some conventional insurance programs.

Who pays if I have a loss?

Your eligibility to participate in the captive is predicated on having a good loss history and effective loss-control programs in place. Nonetheless, losses may occur. The captive is structured to provide coverage for losses within a set threshold determined by the captive’s board of directors.

Losses falling within this range will be paid from the assets of the captive up to each member’s actuarially established allowance for projected losses. Large losses exceeding the captive’s retention levels will be offset through the purchase of reinsurance.

In the event a member’s cumulative losses exceed their total loss allowances, these losses will be shared with other captive members.

As a last resort, financial support would also be forthcoming from an insurance carrier whom the captive will select to “front” the overall program.

If I have few or no losses, when do I see my savings?

The time elapsed from the date the loss actually occurs to the time when all associated claims have been settled varies from weeks to months to years, depending on the nature of the claim and the claimant.

Consequently, the captive’s board of directors defers distribution of “unused” member premiums for a period of time to make certain that sufficient funds are on hand to pay for the respective year’s claims.

If at that time the board is confident of the disposition of that year’s claims, they may elect to return to the member his/her outstanding contribution balance.

Your savings will also be reflected in the contribution which the actuaries develop for your subsequent captive policy year.