How Does Captive Insurance Work? You May Not Need It

Posted in: Commercial Insurance, Risk Management Consulting

I have been working with clients to build captive insurance companies for more than 20 years in a variety of industries including banking, healthcare and manufacturing. A captive is an extraordinary tool, so don’t get me wrong when I say “you may not need a captive.” What I mean is that you don’t have to go through all of the steps and incur all of the expenses of forming and managing a captive insurer in order to better manage your risks. In order to better understand why you may not need a captive, it’s first important to define a captive insurance company.

What is a Captive Insurance Company?

A captive insurance company is a closely held insurance company whose insurance business is primarily to insure the exposures of its owners and in which the insureds are the principal beneficiaries.

How Does Captive Insurance Work?

Captive insurance companies are alternative risk transfer vehicles that provide captive insurance to fund the risk exposures of those affiliated with the program.

Captive Insurance Company Pros and Cons

The main benefits of creating a captive are:

  • The ability to fund for the “coverage” of difficult to insure exposures
  • Direct access to the reinsurance market
  • Extend coverage to third parties

Generally companies with these traits benefit from using a captive:

  • Their losses are predictable;
  • They want to retain a significant portion of their losses;
  • They want to manage and control their claims;
  • They think they manage their risk effectively
  • They want to reduce the amount of risk transfer insurance premium.

But while these all may seem like good reasons to create a captive insurance company, there are costly downsides associated with forming a captive insurance company. Your company will be required to become a registered insurance company – which in turn will require you to hire an attorney, an accountant, a captive manager, and to appoint a board of directors. There is often a requirement for an annual board of directors meeting in person in the captive domicile.

The benefits of having a captive have also narrowed over the years. The tax-deductibility of premium paid into an owned captive went away a long time ago and the insurance underwriting industry has developed more efficient ways to allow their insureds to share risk.

Hence, you may not need a captive.

In some cases all you really need is to pursue a high deductible or retention program option with your insurer. Alternatively, you may self-insure the predictable portion of your loss exposure and unbundle your insurance services, which means that you buy insurance coverage above your own retention level, hire a third party administrator to handle your claims and other loss control services that you might otherwise might be getting from your insurers.

Ok, so when DO you need a captive?

A captive may make sense when a third party shares in the insurance coverage and is paying the premium. The captive then becomes a profit center rather than an expense. There are often situations where a bank, a customer, or a business partner requires insurance specifications that preclude a large deductible or retention. I’ll talk about these situations in my next post.

If you have any questions about captives, retentions, or unbundling insurance services, please feel free to contact me directly at