When to Consider a Captive

A captive insurance company is not a suitable option for all insureds, in all situations. Before exploring the feasibility of a captive, an insured and its advisors should determine whether the following criteria have been met. These criteria are an indication of whether a captive program could make sense.

1. Good loss experience

The insured will be assuming responsibility for the payment of losses under a captive program. If historical loss ratios are high, then it is likely that the captive option will result in considerably increased cost for the insured. As a rule of thumb, captive expenses including fronting and reinsurance costs usually comprise 35-40% of captive premium. If loss ratios are greater than 65% of premium, then the captive is likely to be a more expensive option than guaranteed cost insurance, unless it can underwrite direct and avoid the cost of fronting.

2. Available fronting and reinsurance

The market for fronting services has become restrictive for captives. The viability of many captive programs is dependent on the availability of a front at a price that does not make the program cost prohibitive. Situations that do not require fronting services can make the captive option more feasible.

3. Financially secure parent

An insured considering a captive will need sufficient financial resources to support the capital investment and the posting of collateral behind the captive program. Regulators are unlikely to approve a captive unless the parent is financially secure. In addition, most fronting companies will require collateral to match the aggregate participation of the captive. The stacking of collateral requirements over a number of years can create a significant financial burden on the parent.

4. Sufficient premium volume

A minimum level of premium volume is required in captive programs to provide stability, absorb the operating costs of the captive and provide a return on the capital invested. While there are captive structures specifically designed to accommodate smaller programs, traditional captive programs typically require a minimum of $750,000 in premium annually to make them viable.

5. Long-term commitment from the insured(s)

Captives are a means for insureds to reduce their reliance on the commercial insurance market and provide stable long-term risk financing. Captive programs will not be the lowest cost option in all years, so to be successful they will require a long-term commitment from their owner/insureds. If an insured is considering a captive purely for short-term premium savings, it is unlikely to be the right solution.

6. Predictable losses

Captives work best for programs that have predictable losses. The more predictable and consistent the losses, the greater the confidence with which premiums and reserves can be set for the captive program. Volatile lines of coverage can be problematic for captives as they are difficult to quantify. Lines of coverage with short claims development patterns can also be problematic as the ability to hold reserves against potential future losses is limited.

The SRS Guide to Captives contains historical information that may no longer be accurate. It is for informational purposes only and does not constitute advice. No reliance should be placed on the information contained within this portion of the site and guidance should be sought from SRS regarding captives and alternative risk solutions. No information contained in the SRS Guide to Captives may be reproduced or copied in any format without the express permission of SRS.