According to the Marsh Global Insurance Market Index, commercial insurance pricing rose 3% in the second quarter of 2023, compared to 4% in the prior quarter. This was the 23rd consecutive quarter in which composite pricing rose, continuing the longest run of increases since the inception of the index in 2012. However, when we are faced with challenges, we adapt, innovate, and develop creative solutions to address those challenges. Captive Insurance and alternative risk financing have been common solutions for businesses as the insurance marketplace scales back capacity and increased rates.
Companies that put a significant emphasis on risk management seek greater control over their insurance programs to stabilize costs and improve margins. This is where captives play a pivotal role. A captive is an insurance company wholly owned and controlled by its insured or group of insureds. What better way to gain control of your insurance program than owning your own insurance company? It creates transparency and stability of insurance costs and provides the insured the ability to access the revenue streams of insurance―primarily underwriting profit and investment income (aka money back into your business).
This solution does not come without risk
The risk to the insured is a balance between risk retention and risk transfer, as most insurance companies buy reinsurance to cover catastrophic claims. A well-structured captive creates this balance through reinsurance contracts or large deductible plans and allows the insured to maximize its risk management investments by profiting off the claims it can control. Additionally, it creates greater stability over insurance costs, as the insured buys less insurance from a third party.
How can a captive achieve the stability you’re looking for?
Captive premium is made up of two key metrics: projected loss costs and fixed expenses. Fixed expenses can include claims management, operating expenses of the insurance company, and the risk transfer element. In most situations, the loss funding makes up 60-70% of the premium and fixed operating costs are 30-40%.
If baseline premium is $500,000 in a Guaranteed Cost setting, a 10% increase in rate would equate to a $50,000 increase in premium. However, in a captive arrangement, the insurance costs are only a portion of the overall premium. Therefore, a 10% rate increase would only be applied to 40% of the premium, or $200,000 in the $500,000 example. The net impact is only a $20,000 increase in costs. While this is a rudimentary example, it outlines the transparency and stability a captive arrangement could afford.
So, is a captive right for your company?
A captive can be structured in many ways, but it is not always the best option for everyone. If you are a business that is getting tired of consistent price increases, has an entrepreneurial spirit, and a sophisticated risk management approach, contact an MMA advisor to determine if a captive could be a solution to today’s problems and beyond.