4. Captive Programs
Captive
insurance involves much more than purchasing insurance -- the insured also
becomes an insurer. A captive is an insurance company that provides
insurance to and is controlled by its owners.
Captives can be wholly owned, member-owned (can be called a group captive) or a
rent-a-captive.
In
these programs, the insured becomes an owner of a reinsurance company.
Premiums paid pay individual losses. An insurance
policy is issued by a carrier that complies with business and regulatory
requirements, although the issuing carrier takes little risk. The
premiums, after expenses, are sent to the captive who
has the responsibility for paying loss. This is
referred to as a “fronting carrier” and they receive a fee for
this.
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The up front
costs for these programs usually fall somewhere between a deductible plan and a
retro plan. Typically, the first year’s premium is equal to the expenses
for that year and the estimated losses for that year on an incurred
basis.
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The expenses are
for the fronting carrier, taxes, loss control, some claims expenses and
reinsurance.
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The captive
protects itself and its members with both specific excess and aggregate
reinsurance
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A letter of
credit, or other collateralization, must be posted for
the difference between the amount paid in and the maximum liability of the
insured. This liability, or downside risk, is often times an amount equal
to one year of estimated losses. Pyramiding of letters of credit can be
Disadvantageous.
There
can be certain immediate benefits to entering a captive program. In a
hard market, the initial premium may be lower than the marketplace because it is based solely on expenses and estimated losses.
Later benefits can be the return of underwriting profit, and investment income
made on loss reserves. There is also the possibility of significant
penalties if the Captive performs unfavorably.
Participation
in a captive is a long-term financial decision and its biggest advantage is
to even out the cyclical nature of the insurance marketplace and provide
reliable, affordable coverage without the need to market each year.
It is not a solution to a short-term pricing problem. It is a Long Term Capital Investment.
First
year costs tend to be higher than a deductible plan. Over time it tends to even out. The captive does, however, provide the opportunity to accrue value
outside of the normal business model and often times outside of the