What Is Captive Insurance?

Captive insurance is a risk-management strategy where businesses create their own licensed insurance company. The “captive” insurance company is able to underwrite specific coverages for the business.

As an alternative risk financing strategy, captive insurance offers certain advantages over traditional insurance. Paying premiums to your business’s own insurance subsidiary has obvious financial benefits, but one of the most important advantages is being able to underwrite highly specific risks. When traditional insurance doesn’t offer coverage for certain risks, captive insurance provides an alternative way to cover them.

Types of Captives

Businesses may use a variety of structures when creating a licensed insurance subsidiary. The main types of captive insurance are pure captive, group captive, segregated cell, and risk retention groups.

Pure Captive

Pure captives are also known as “wholly owned captives” or “single-parent captives.” In this captive, the captive insurance company is a wholly owned subsidiary of one parent company. The captive insures only the parent company and its subsidiaries, and the parent company maintains complete ownership and control of the captive.

Pure captives offer some of the most customizable coverage options. Since coverages are underwritten for only one parent company, they can be highly tailored to that company’s needs.

Operating a pure captive requires significant resources and risk management expertise. For these reasons, large corporations with extensive risks and resources most often use this strategy.

Group Captive

Group captive insurance insures several companies, and the captive is owned and controlled by the group. All group members pay premiums and can file claims.

Pooling together with other companies has two main benefits. First, companies don’t need the same resources and expertise as pure captives require. Second, potential losses are spread across a broader group so that no one company is fully exposed to claims-related risk.

Companies usually form group captives with other companies in the same industry, allowing the captive to tailor coverages for the industry, if not for any one specific company. However, it’s important to ensure that each participating company has similar risk management goals.

The group captive strategy tends to work best for mid-sized companies because they can enjoy the benefits of captive insurance without needing as many resources.

Segregated Cell Captive

Segregated cell captives (or protected cell captives) bring multiple companies together, but they don’t have to be related like they usually are in group captives.

All participating companies pay premiums to the same captive, and there’s a core capital reserve account that underpins the whole captive. Separate cells are used to segregate companies based on their assets and risk exposures.

Each segregated cell effectively operates independently of the others, which allows cells to offer different coverages and premiums within the same captive. Claims against one cell also won’t directly impact another cell. Essentially, there’s a group of coverage underwriters operating within the same insurance company.

Segregated cell captive may be an option if an industry-specific group captive isn’t available. Many medium-sized companies might choose segregated cell, finding it more cost-effective than either pure captive or traditional insurance.

Risk Retention Groups

Risk retention groups (RRG) bring together companies or professionals who are engaged in related or similar business. These groups can provide coverage in all 50 states after getting licensed in any one state, although the coverages they can provide are limited to commercial liability coverages, including general liability, professional liability, and product liability.

One of the main purposes of RRGs is to make certain liability coverages more accessible to businesses or professionals within an industry. Professionals and businesses of different sizes might use this option if traditional insurance coverage is either unavailable or unaffordable.

Common Covered Risks

• Workers’ Compensation: For work-related injuries and illnesses that result in lost wages and medical expenses.
• General Liability: For common risks that most businesses face, such as causing a third-party injury or damaging a third party’s property. It usually also covers advertising injury.
• Commercial Auto: For company-owned and company-operated vehicles, typically covering accidents and other incidents.
• Professional Liability: For errors made while providing professional advice or services.
• Cyber Liability: For data breaches, ransomware attacks, phishing scams, and other modern-day digital risks.
• Business Interruption: For lost revenue if a business must close for a prolonged time because of a covered event.
• Property Insurance: For damage to commercial buildings, equipment, inventory, and other physical assets.

Benefits of Captive Insurance

• Custom Coverage: Policy terms can be tailored to the specific risks that one or several businesses face, which is especially important if adequate coverage isn’t available from traditional insurers.
• Cost Savings: Captive insurance allows businesses to bundle certain risks.
• Improved Risk Management: Because the company and the insurance subsidiary are connected, there’s a strong cross-organizational incentive to implement loss-control measures.
• Long-Term Stability: Companies can establish their own premiums and coverages, so are somewhat insulated from the commercial insurance market.
• Enhanced Claims Handling: Streamlined claims processing affords more direct communication and often provides faster settlements.

Disadvantages of Captive Insurance

• Upfront Costs: Establishing a captive requires significant initial capital to regulatory licensing fees, professional advisory fees, and many other costs. These can be mitigated by using a group captive or segregated cell captive.
• Regulatory Complexity: Captives must comply with the laws of the jurisdiction in which they are domiciled, both when formed and thereafter. Ongoing compliance requires specialized expertise.
• Potential High Losses: If claims-related losses are greater than anticipated, the captive’s owner must absorb the additional costs. Long-term savings don’t guarantee savings in any one year.
• Operational Requirements: Managing administration, actuarial research, claims payments, and other operations are extensive. They’re often beyond what any mid-sized business may sustain.
• Risk Concentration: Relying heavily on a captive could leave an organization without sufficient coverage if a catastrophic event exceeds the captive’s reserves.

Use Cases for Captive Insurance

Companies might form or participate in a captive for various strategic reasons, such as the following:

• Obtaining coverage for hard-to-insure risks.
• Customizing policy terms and limits.
• Retaining underwriting profits and investment income.
• Reducing premium costs over the long term.
• Stabilizing insurance costs regardless of market conditions.

Interested in Learning More?

Captives can be beneficial, but they’re not right for every organization. If you still have questions, please contact our experts at Allied Insurance Managers. We’re proud to be one of Michigan’s largest independent agencies and have nearly 40 years of experience helping businesses nationwide. Our team can help you connect to specialized service providers, assess the feasibility of a captive for your business, offer risk identification, and provide ongoing captive management support.