Workers' Compensation Captive Programs
A captive program 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.
We will concentrate on the member-owned, or group captive.
In these programs, the insured becomes a member or owner of a reinsurance company.
With other businesses, often of similar industry type, premiums paid form a pool to pay individual losses and some shared 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.
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.
The expenses are for the fronting carrier, taxes, loss control, some claims expenses and reinsurance.
The captive protects itself and its members with both specific excess and aggregate reinsurance.
A letter of credit, Bond 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.
In addition, there will be some provision to share in the obligation for the severe losses of other members.
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.
However, 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. 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 United States.
Advantages
- Stability of coverage and pricing
- More control over claims and service
- Return of unused loss fund and investment income
- Can participate at lower premium levels than deductible plans
- Multi-state capability is easier
Disadvantages
- Possible significant penalties
- Long-term capital investment
- Pyramiding of letters of credit
- Responsibility for other's losses