A recent article in Forbes magazine highlights the use of captive insurance companies among private equity firms for errors and omission insurance, directors and officers liability and health insurance over traditional products. Additionally, captives are increasingly being used to provide mergers and acquisition insurance.
Why are captives insurance companies so attractive to private equity firms? Firms can effectively use captives to manage their own risks. Additionally, captives can be used to address the risk of portfolio companies, benefitting both the private equity firms and the senior management of the portfolio companies. The key, of course, is to conduct a complete analysis including claims histories to see if and where a captive is the better choice over traditional products for a private equity firm. Also critical is to make sure there is no question about the validity of the risks being covered.
Back to the Basics
A captive is an insurance company that insures all or part of the risk of its parent company. Generally speaking captives provide the following advantages:
Lower Insurance Costs. Through the creation of a captive, the parent seeks to retain the profit with the group rather than have it go to an outside party; i.e., insurance carriers. A captive can help to reduce insurance costs by charging a premium that better reflects the parent’s loss experience instead of a certain industry as a whole.
Improved Cash Flow Benefits. The ability of a captive to generate investment income from unearned premiums received is often a critical advantage in forming a captive. This is particularly true where premiums are paid in advance and losses are paid out over a lengthy period of time (which, in turn, depends on the kinds of risks insured).
Unavailability of Coverage. A captive may offer coverage in a situation where the commercial market is unable or unwilling to provide coverage for certain risks. In other instances, a captive may provide a solution when the price quoted seems high.
Risk Management. A captive can serve as the focal point for risk management and risk financing activities of its parent organization. An effective risk management program will result in recognizable profits for the captive.
Enhanced Loss Prevention and Claims Management. A captive establishes its own claims handling policies and procedures, which can result in reducing the time needed to process and pay claims. Robust loss prevention measures will assist in stemming losses in the first place, improving the captive’s overall risk profile and reducing claims.
Access to Reinsurance Market. Reinsurers operate on a lower cost structure than direct insurers and are able to provide coverage at advantageous rates. As a result of using a captive to access the reinsurance market, the buyer can more easily determine his own retention levels and structure its program with greater flexibility.
Tax Benefits. When properly planned and implemented, a captive insurance company can serve a valuable business and tax planning function.
Caitlin Morgan specializes in alternative insurance solutions and can assist you with determining whether a captive is right for your client. Give us a call at 877.226.1027.