The insurance market is facing obstacles that it never has before. Changing business models, new vulnerabilities, and a worldwide health crisis are only a few of the issues. As rates continue to increase and capacities decrease, companies search for viable solutions to their insurance needs. Many businesses are turning to captive insurance to solve their unique problems. Let’s review the details of this dilemma and how captive insurance plays a role.
The Hardening Insurance Market
For nearly two decades, companies have enjoyed lower premiums and comprehensive coverage in what’s known as a soft insurance market. The characteristics of a soft market include plenty of competition, resulting in lower rates and increased capacity. However, these traits can’t last forever, and it’s not what’s currently trending. Instead, rates and retentions are increasing.
Keep in mind that the insurance market’s rhythm is steady, shifting slightly every few years or so. Unfortunately, these past few years have morphed the insurance landscape into a hardening market.
Many factors contribute to this transformation. The COVID-19 crisis, rising litigation costs, and social upheaval are all influencing variables. Several insurance lines are experiencing an upward trajectory, such as cyber liability and professional liability (aka errors and omissions) insurance. In fact, directors and officers (D&O) insurance is facing the hardest market in decades.
Understanding the Challenges Companies Face
Although the insurance market began hardening before the worldwide health crisis, COVID-19 hasn’t improved the situation whatsoever. Coronavirus-related workers’ compensation claims have skyrocketed across the US, and we expect them to continue trickling in as time goes on. And that’s just for starters.
The paramount issue has been COVID-19 shutting down businesses due to stay-at-home orders or social restrictions. Many companies are unsure whether their policy covers losses or damages related to COVID-19. That said, most policies cover fires, storms, and various property damage — but many other carriers state COVID-19 as an invalid cause. Naturally, massive litigation surrounds these situations, resulting in business interruption claims being a significant factor in rising rates.
Public companies face 15% to 25% increases, while private companies face 5% to 15%. According to Kevin LaCroix, Executive Vice President for RT ProExec, “others are continuing to see increases beyond that range.” It’s no surprise that unicorns are in the same boat as public companies.
Why Captive Insurance Is a Solution
With all the challenges companies face nowadays, many are searching for a more affordable way to obtain the insurance coverage they need. More businesses have turned to captive insurance for a solution.
What is captive insurance?
Briefly, captive insurance is a wholly-owned subsidiary insurer providing risk management products and services for its parent company. We discuss details below, but let’s debunk a few myths first.
Captive insurance is a mature solution for companies to manage their unique risks. However, it’s not necessarily the “enemy” of traditional insurance. Instead, captive insurance is merely alternative risk finance. Also, captive insurance isn’t simply self-insurance as the structure is slightly different from those models; however, it is a form of corporate self-insurance.
Think of captive insurance as a way to actively take part in your company’s risk profits, not only accepting unwanted costs. When structured cost-effectively, captive insurance finances more than only small exposures. It tackles the significant risks, too.
How it works as a solution
Captive insurance’s popularity has increased in recent years, with 76 new captives being formed this year. Unsurprisingly, the pandemic has only encouraged companies to consider this option as a viable solution. But how does it work, and why?
When a company chooses to use the captive insurance model, it creates a separate entity to provide insurance services. The business plays the role of the parent company, and it pays premiums to the newly-formed captive company. Consider that this entity has its own overhead costs and compliance issues to manage. As a result, it’s common for larger corporations to form captives but rely on third-party insurers to insure against other perils.
The structure isn’t incredibly complicated, and there are a handful of tax incentives for using this model. For example, many parent companies will locate the captive in what’s known as a “tax haven.” These locations often include Bermuda and the Cayman Islands to avoid harsh tax implications. But the internal revenue service (IRS) won’t turn a blind eye to companies abusing the captive insurance solution to evade taxes.
Reasons to Consider Captive Insurance
As mentioned, captive insurance is a solution that only fits a specific company or corporate lifecycle— particularly a mature business. Remember, there are substantial expenses when insuring your own risks. For example, if your business experiences a significant loss, you might face bankruptcy as your pool of risk isn’t as diverse as a private insurer.
However, this solution is an excellent option for some businesses looking to manage risk and reduce expenses. As with any business decision, a cost analysis is necessary.
Still, going this route reduces your reliance on private insurers, and it can potentially cover risks that carriers typically shy away from. Your company will also have more access to reinsurance markets to help spread a broader net of coverage. Plus, many management teams enjoy having the option to customize their coverage more precisely.
The Next Step
Even with the benefits of captive insurance, it’s imperative to review your claim history and financial stability. These two factors could make or break the success of any captive insurance entity. Better yet, talk with a seasoned insurance professional about your options to find the most bang for your buck.
Understanding the details of what coverage your company needs can be a confusing process. Founder Shield specializes in knowing the risks your industry faces to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.
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