TAKING THE FRUSTRATION OUT OF WORKERS' COMPENSATION!
TURNING PREMIUMS INTO PROFITS
The key concept behind captive insurance is, in essence, self-insuring your risks. YYou might think that self-insurance is too much for you. But every business is basically self-insuring; it is just a matter of to what degree. Every business that buys an insurance policy has a retention that they are self-insuring, also known as a deductible.
Most businesses do not want to pay a large, unpredictable $1,000,000 claim out of their own pocket, so they purchase an insurance policy from an insurance company. Typically they would buy a Guaranteed Cost insurance policy meaning that, other than the deductible(s), they will pay no more than the premium for their insurance protection.
Many businesses that focus on reducing the likelihood of having a claim through safety and their business culture take on some risk to reduce their premiums. They may choose to keep the first $1,000, $10,000, $25,000, $50,000 or more of any claim (a deductible) and let the insurance company take on the rest. They know that the bigger amount they take on, the lower their premiums will be as most likely anything that may happen will likely be small versus catastrophic.
The concept of using a captive is like taking advantage of using larger deductibles, and captives allow you to control what you will have to ultimately pay for your insurance protection, all while reaping the benefits when you perform better than the worst-case scenario.
Just so you know the same concern over paying out huge claims applies to insurance companies as well. They do not want to take on millions of dollars in claims by themselves, so they go out and buy insurance themselves, which is called reinsurance. They keep only a portion of the potential claims, say the first $250,000 or $500,000 of a claim, and then let the reinsurance take care of the big claims. As the chance of something occurring that will bring about a claim of over $250,000 is very small, the cost of reinsurance is significantly lower as compared to the cost of insurance for the first $250,000.
The insurance companies can charge the largest amount of their premiums, and make most of their profits, from insuring these small, predictable claims and letting others (reinsurance companies) take on the large, unpredictable million dollar claims.
From the “insurance side,” a captive insurance program looks, acts and feels like a typical guaranteed cost insurance program. You purchase a standard, guaranteed cost insurance policy from and pay premiums to a regulated insurance company. The insurance company, or an approved Third Party Administrator, will pay your claims. You will be able to deduct your premium when it comes to taxes, and you will even have a year-end premium audit. No one outside of your company will know that you are an owner of a captive or that your policies are reinsured by your captive.
On the “captive side” is where things change.
Your captive enables you, individually or as part of a group, to fund and pay for those smaller, predictable claims. Therefore, the potential underwriting and investment income profits, which normally would go to the insurance company to insure poorer quality businesses and benefit their shareholders, would go to you or the group. In essence, you are able to bypass the insurance company in the traditional insurance model and access the reinsurance marketplace directly to take care of those large, unpredictable claims, thereby dramatically reducing your insurance costs.
Instead of any insurance company issuing you an insurance policy, a captive uses a “fronting” insurance company to issue the policy. The fronting company keeps a small percentage fee for the issuance of your insurance policies and dealing with any necessary regulations, state or federal filings, etc. The fronting company will then “buy” reinsurance from your captive and send it the net remaining premium. The fronting company is just what its name implies; it is the front or outward face of your insurance program.
INTRODUCTION TO CAPTIVES
BENEFITS OF GROUP CAPTIVES
TYPES OF CAPTIVES
IS A CAPTIVE RIGHT FOR ME?
HOW TO JOIN A CAPTIVE
HEALTH INSURANCE CAPTIVES
TURNING PREMIUMS INTO PROFITS BOOK
As you can now see, your captive insurance company will really be a reinsurance company for your policies. Instead of insuring the large, unpredictable claims, you or your group insure the smaller, predictable ones and then buy your own reinsurance for the large, unpredictable claims.
Your captive insurance company will manage and pay all of the claims for you or your group. After all expenses and amounts are paid out for claims, and if your captive takes in more money than it spends, it generates an underwriting profit that may be returned to you as the owner(s) of the captive.
However, much like a regular insurance company, you do not want to have your captive pay for all of your potential claims by itself. Therefore, you must purchase reinsurance for the captive in order to limit what you may have to potentially pay out. Through the re-insurance your captive purchases, your captive insurance company will function much like high-deductible program where the captive pays for all claims up to a fixed point, such as $250,000 or $300,000. The captive will pay for claims up to that per claim amount for any single claim, and will pay for all claims to a point where the captive's aggregate deductible threshold is crosses and your reinsurance (your captive purchases from another insurance company) starts to provide excess coverage.
After one or both of these deductibles have been exceeded, the excess reinsurance that the captive purchased will pay any additional claim amounts. The excess re-insurance thereby limits how much you may have to pay out for claims in a particular year.
As the captive is an insurance company that has to pay the operating expenses, in addition to paying a premium to fund your claims, you will need to pay fees for the fronting insurance company, the captive's reinsurance company, the third-party claims administrator, and other normal operating costs of an insurance company.
Just as with traditional insurance companies, the premiums that are received by your captive are not spent right away. They need to be set aside as reserves to pay claims. While the monies are held by the captive, the funds can be invested and any proceeds are available to pay claims or be returned as profits to the captive owners. Therefore, you may receive investment income to help pay for your claims and/or be returned to you as part of the captive’s profits.