The Six Cs of Captive Value: Focus on Cover
A powerful benefit of a captive insurance company is that it can issue proof of insurance (cover note or an insurance policy) to comply with contractual obligations. Sometimes confused with compliance, which focuses more on meeting regulatory requirements, “cover” is more about having access to coverage that may not be available in the commercial insurance market while remaining compliant with applicable regulations.
The parent company may prefer to retain certain risks that it is contractually obliged to insure, such as workers’ compensation exposures or medical malpractice exposures. Self-insuring these risks through a captive insurance vehicle provides evidence of insurance and captures premium that would otherwise go to third parties.
Reasons for Forming a Captive Insurance Vehicle — The Six Cs
Other times, a firm may be trying to obtain coverage but can’t get down to the budgeted level that the parent organization needs. Using the concept of “cover,” a captive can be used to access coverage that can be tailored to the organization’s insurance program and its price parameters.
A captive can also provide flexibility to firms seeking to adjust corporate deductibles. The firm’s captive can formally insure any newly exposed layers that the organization can’t or doesn’t want to insure in the traditional market as well as provide coverage to business units that can’t afford a higher retention without negatively impacting their financials.
For example, XYZ Company has 20 entities, 16 of which wanted a higher retention for their workers’ compensation (WC) programs due to lower losses. The risk manager agreed that with strong risk controls in place, the organization could afford to self-insure those entities and that it would put the firm in a favorable position regarding their total cost of risk.
Unfortunately, the remaining four entities, due to differences in operations that are critical to the firm’s operations but are more prone to WC losses, may have had difficulty meeting their goals. These entities were openly opposed to any changes to their retained losses. XYZ decided to increase the corporate retention and use their captive to insure the difference in the layers for the four business units that couldn’t afford to take a large loss on their balance sheets.
By consolidating the program into one vehicle, XYZ created less volatility for the critical business units, covered potential losses with self-insurance, and enabled the organization to purchase a higher deductible plan going forward.
Issuing proof of insurance is one of the many benefits a captive can offer. If you think a captive vehicle would benefit your organization, work with your tax and accounting teams and other advisors to determine the setup that meets the unique needs of your organization.