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Why Join a Group Captive for Insurance

Post: Dec. 5, 2018

A captive insurer is an insurance company that is wholly owned and controlled by its insureds; its primary purpose is to insure the risks of its owners, and its insureds benefit from the captive insurer’s underwriting profits. Single-parent captives have only one owner. Group captives, on the other hand, are formed when a group of individuals or entities comes together to jointly own a captive insurance company. Sometimes they are sponsored by industry associations for the benefit of their members, hence the alternative name “association captive.”

Why Join a Group Captive?

Like single-owner captive insurers, group captive insurers offer the key benefits of pricing stability, insurance coverage stability, and improved services. However, the use of group captives is feasible for organizations that do not have adequate capital resources to form their own single-parent captive. Other benefits of the group captive approach are examined below.

  • Improved Loss Forecasting and Greater Risk Retention Potential – Given the law of large numbers, overall claim experience can be predicted with a higher degree of confidence for a group captive insurer than if a single organization’s exposures were being covered.
  • Mass Purchasing Power – Group captives can obtain services and reinsurance more cost-effectively than if each member of the group attempted to obtain such services and reinsurance by itself.
  • Reduced Overhead – General management overhead is reduced in a group captive insurer due to economies of scale. The per-member cost of administering a group captive is decidedly lower than if the identical coverage is obtained in a single-owner arrangement.
  • Increased Loss Control Emphasis – The group captive structure imposes a sharing of losses on its members. This ultimately produces peer pressure and healthy competition among the members to enforce safety practices and control claims. No member wants to feel as if it is generating more than its “fair share” of claim expenses. Participants in a group captive might find themselves voted out, nonrenewed, or canceled if they cannot live up to the group’s loss control standards.
  • Retention and Return of Profits in a Cost-Effective Manner – The majority of group captive insurance companies pay dividends or otherwise distribute underwriting profits and interest to their owners or insureds. Depending upon how the captive program has been set up, the group captive can be financially advantageous, as compared to a noninsurance risk retention program or commercial insurance.


Problems Inherent in Group Captives

Because they have multiple owners, group captives are subject to a number of potential difficulties that do not plague their single-owner counterparts. These disadvantages are noted under the following headings.

  • Formation/Capitalization Delays – As the number of potential members of a group captive increases, the time required to form and capitalize the venture will increase proportionately.
  • Decision-Making Problems – Once a group captive has been established, the differing needs of its members may make it difficult to reach consensus on operational issues.
  • Rating and Cost Allocation Controversies – Honest differences of opinion may arise between members as respects the rating process. Depending on the rating plan that is devised, some members will fare significantly better or worse than others.
  • Potential Higher Costs – A group captive insurer’s initial costs are usually higher than traditional loss funding alternatives. Further, participation in a group captive might require an initial capital contribution from each member. Captive participants must keep the long-term goals of stable pricing and availability of coverage in mind. Their commitment should not be swayed by swings in the insurance market cycle.
  • Profits and Earnings Distribution Conflicts – Another major area of potential disagreement pertains to the distribution of underwriting profits and earnings that accumulate on those profits. Many problems are avoided when a predetermined earnings distribution plan is in place before the captive begins to operate.
  • Reduced Degree of Confidentiality – Potential group captive members are required to divulge a substantial amount of financial information. Most small business owners prefer to keep this information confidential.
  • Additional Management Time – Volunteer management on boards and committees is one of the reasons group captives’ costs can be kept low, but in exchange, this requires the volunteers to expend their time and effort to manage the captive.
  • Different Growth Rates of Owners When a group captive is initially created, the members/owners arrive at a consensus on the retention levels and amount of risks insured. Over time, different members may grow much larger and desire higher retentions and/or coverage amounts.
  • Potential Withdrawal of Participants – Group captives face the threat of potential large-scale capital withdrawal by their members. Of course, this could severely impair the captive’s continued financial well-being. Accordingly, when group captives are formed, clear and unambiguous procedures must be developed for dealing with these circumstances.
  • Potential Tax Problems – When comparing group captives to conventional loss funding programs, captives may appear to represent the better opportunity to deduct the premiums from federal income taxes. This is especially true when comparing a group captive to a typical large deductible plan. However, unless the captive is able to withstand the Internal Revenue Service’s test regarding risk shifting and distribution, premium tax deductibility could be in jeopardy. Group captives also present additional tax issues.

Is Participating in a Group Captive Right for You?

A number of crucial factors should be considered when deciding whether to participate in a group captive. If you are interested in learning what for factors are and learning more about the Group Captive endorsed by the Council of Industry contact Owen McKane at the Reis Group.

  • Who controls the facility, and are there any conflicts of interest?
  • Are there any provisions for the withdrawal of participants and the entry of new participants?
  • What is the minimum required participation time?
  • How are premiums determined?
  • What, if any, risk control efforts does the facility require of participants?

Once these and other questions are answered and the decision to participate in a captive is made, each member/owner must continue its commitment to ensure the captive remains truly workable.