Insurance

Enterprise Risk Captive Basics Part I: Captive Rate Structure

As enterprise risk captives become more widely known in the U.S. market, they’re getting more attention from consumers, insurance agencies, and regulating bodies. Regulating agencies are looking at domestic captives to make sure they are following the rules laid out under the IRS’s guidelines for enterprise risk captives. Meanwhile insurers and companies interested in captives are studying costs and rates, sometimes comparing captives to traditional commercial rates.

Captive rates vs. commercial insurance rates

Captive insurance companies differ greatly from traditional commercial insurance companies, which makes comparing the two a bit like the classic apples and oranges analogy. As enterprise risk captive managers, our approach differs from a commercial insurance underwriters, particularly in the type of risk we manage on behalf of our clients. In fact, captives often exist to provide coverage for damages that commercial insurance companies don’t cover.

Pricing captives involves a number of factors. First and foremost, a captive is designed to cover the most catastrophic events (we’ll take a deep-dive into loss ratios in Part II), a primary consideration in pricing the cost of a captive. But there are additional issues that we need to consider. As captive managers, we are like an insurer in one key respect: We act as a highly specialized insurance company from the moment we begin the underwriting process until the captive is dissolved. That means we have to staff like an insurance company, work with underwriters, oversee compliance to all regulatory agencies, and assist our clients with ongoing management of their captive.

When you take a long view of a well-run captive, the pricing is generally on-par with the 10 – 15 percent profit margin that most healthy commercial insurers report.

Expense ratios

If you’re shopping for a captive or a captive management company, ask about expense ratios. A well-managed captive should be able to meet a 7 – 10 percent expense ratio relative to premium costs. This expense ratio will be well under a typical commercial insurance provider that has huge operating expenses (around 30 – 35 percent) they are writing commercial, claim-frequency-driven business. The very nature of a captive is to be a smaller and therefor more efficient risk management tool. Once a captive begins to get too big, it will start mirroring the commercial market.

Questions to ask your captive manager

A captive is a huge investment, and a large undertaking. Ask plenty of questions before you work with a captive company. Some of a captive’s biggest costs a captive has should relate directly to the service they provide. Here are some of the main questions you should ask a potential captive manager:

  • What kind of actuarial services do you use? Actuaries drive many of the decisions the captive makes when it comes to underwriting, and you want to be sure that the captive has excellent actuaries who work with the company.
  • How many accountants are on staff? Captives require year-round accounting services, so you want to be sure that there are enough good accountants on board to cover all the captive clients. Ask about turnover, too – working with an accountant long-term who knows you and your business is helpful.
  • Describe processes and documentation for me? Ask the captive manager very specific questions about the documentation they’ll provide to you when your captive is launched, and how they maintain and update all legal and regulatory documents monthly, quarterly, and annually.
  • How quickly can your firm react to specific questions from regulatory agencies? The answer should be “within 24 hours.”
  • What kind of involvement will you have with my company and board of directors? A good captive manager will have an ongoing relationship with your company, working with your financial and legal departments to ensure ongoing communication and good management of the captive. Your captive manager will also attend your board meetings to make sure your board is well informed about the captive (especially if you’re nominating any changes to the captive) and to make sure your company is meeting all of your legal and regulatory obligations on a corporate level.

Word-of-mouth

Don’t just ask the captive manager these questions, try to get recommendations from clients and other professionals in the industry that they might work with.

The real value of the captive is a lower expense ratio that allows you to allocate more dollars to risk. You’re getting specialized management on a focused group of coverages. A captive is a long-term commitment, so make sure you’re doing business with a company that’s operating efficiently with a focus on your business.

We’d be happy to answer your questions and talk with you about enterprise risk captive solutions. Contact us.

Read Part II of our Enterprise Risk Captive Basics series on captive loss ratios.