USA Risk Group’s Giles Hobday, account manager, and Scott Stollmeyer, vice president, explore the key factors businesses must weigh when considering forming a captive, from minimum capital to risk management and regulatory compliance
One of the most common questions newcomers to the captive insurance industry ask is what size they need to be to form their own captive insurance company. To form your own captive, there
are many different factors to consider. One of these will be how much premium needs to be written each year to make the captive feasible. A captive that does not write enough premium, will likely
be unable to cover essential expenses such as service provider fees, administrative expenses, regulatory fees and other operating costs, while still having enough left over to cover its insurance
claims/losses.
As a general rule of thumb, a stand-alone captive will need to write at least US$750,000 of premium annually to be considered a viable prospect — that is on top of providing initial capital, which will
typically be at least US$100,000-250,000 (once-off) to capitalise the captive when it is formed. The US$750,000 number is simply a guideline and could be higher or lower depending on a variety
of different factors. The rest of this article will explore some of the most common considerations and options when forming a captive.
Minimum capital requirements
You typically need to put up a minimum amount of capital upfront to establish a captive insurance company. The amount varies depending on the jurisdiction but can range from US$100,000 to
US$250,000 for smaller captives, and more for larger ones. The amount of minimum capital is set by the relevant jurisdiction’s regulator and will normally depend on the type of insurance being
written and the risks involved. Capital requirements may increase with the level of premium being written, depending on the type of risk and applicable regulations. Capital is generally provided in the
form of cash or a letter of credit.
Insurance Needs
Captive insurance is most beneficial for businesses or groups with significant insurance needs, such as high claims frequency or specialised risks. Captives also tend to favor businesses with
lower loss ratios than the rest of their industry. Various benefits can be achieved through captives including, but not limited to:
• lowering overall cost of risk
• providing tailored coverage where there is low or no capacity
in traditional insurance markets
• control over handling of claims
• realising investment income on collected premiums.
The most common lines of business underwritten in a captive include: workers’ compensation and employers liability; commercial general liability; and auto liability. While some companies may pay significant insurance premiums to their commercial insurance companies, this is not an automatic indication that a captive is a viable option.
It is worth noting that the US$750,000 guideline will likely increase if you are aggregating multiple different types of insurance caoverages such as those mentioned earlier as the different lines of risk may need to be assessed individually rather than together in aggregate.
Risk management experience
Since most captives are designed to underwrite the risks of the parent company (or group), there needs to be a proper understanding and constant monitoring of the risks involved. Captives are a long-term solution and a significant level of commitment is required from the leadership team of the insured to the captive insurance programme. If a captive is including risks unrelated to the parent company (i.e. third-party risk), then generally, risk management requirements will increase.
Operational and organisational structure
You will need to set up an infrastructure to manage the captive. This typically includes appointing a board of directors to oversee the captive and engaging an insurance manager, actuary, tax adviser, auditor, legal adviser and other service providers as needed. Generally, service provider costs add up to around US$100,000 per year for a basic captive programme.
In addition, underwriters, claims administrators, or insurance brokers may be needed to handle the insurance aspects of the captive. Annual operating costs will need to be covered by the premium paid into the captive.
Regulatory compliance and licensing
Captive insurance companies are regulated by the jurisdiction (a.k.a. domicile) in which they are formed and licensed. For example, in the Cayman Islands the regulator is the Cayman Islands Monetary Authority (CIMA) while in North Carolina the regulator is the North Carolina Department of Insurance (NCDOI).
You will need to comply with the local insurance regulations, which may include periodic regulatory filings, audits/examinations, and maintaining capital and solvency requirements. The compliance function is typically handled by your insurance manager but ultimate responsibility for compliance rests with the board of directors.
Types of captives
The most common type is a single-parent captive, where a parent company owns the captive and the captive insures the risks of its parent. With stand-alone captives, the parent company as the sole shareholder will have the authority to appoint the board of directors who control the company.
Group captives are also popular, where multiple different insureds can come together to share risk and form a captive that is owned by some or all of the members within the group. The members in these group captives may share the same type of risk (homogenous) or different types of risks (heterogeneous) with each other.
Segregated portfolio companies (also known as rent-a-captives or protected cell captives) are where smaller businesses can ‘rent’ a segregated portfolio (or cell) within an existing captive company, rather than forming their own stand-alone captive.
Both group captives and rent-a-captives avoid or reduce many of the costs of forming a stand-alone captive. In addition, because risk is being shared across multiple insureds, premium requirements can sometimes be lower. However, with group captives and rent-a-captives, some element of control is forgone due to the sharing or renting of the captive structure.
In summary
There is no strict size requirement, but generally, companies need to have a certain scale to make the formation of a captive feasible. A comprehensive feasibility study should be completed prior to forming a captive.
If you are considering forming a captive, it is a good idea to consult with an insurance manager, insurance broker, or legal adviser as a first step. USA Risk Group as an independent insurance manager, is well positioned to provide you with a truly objective analysis of whether a captive is right for your business.