There are many reasons for forming a captive insurance company, but in most instances they are formed by a company or business entity as a way to insure the risks of its parent corporation. There are circumstances when insurance cannot be purchased from commercial insurance companies for a particular business risk. When these situations exist, companies within an industry will decide to form a joint captive insurance company for this exact reason. But it can be tricky, and without knowledge of how to properly form a captive it is suggested to hire someone knowledgeable in captive consulting.
For example, premiums paid to a captive insurance company are deductible as a business expense for tax purposes, according to the Internal Revenue Service. However, sums set aside in a self-insurance program are not deductible as a business expense. This could be a costly error on the part of the business partners not engaging in a captive.
Failure to implement a sound business plan could result in a catastrophic occurrence, or series of occurrences, which could bankrupt the company, which further illustrates why forming a captive may be the feasible alternative.
Reasons for forming a captive insurance company
- Mitigating risk reduces exposure
Captives allow the business partners to structure the type and amount of risk they wish to retain. This may include risks that are currently uninsurable or insurable only at prohibitive costs.
- Improving cash flow is a vital resource
Maintaining control of premium payments and directing the management of those funds according to the investment strategy accomplishes this. This will maximize the yield on the portfolio commensurate with risk and allows the company to structure the maturities to meet their cash flow requirements.
- Stabilizing price fluctuations
Captive insurance may also stabilize risk management costs. By insuring through a captive, premiums are determined by the loss experience of the company, rather than the experience of a peer group, whose loss ratios may be much higher.
Captive consulting is an essential way to correctly form a captive in order to minimize costs, bypassing commercial brokers and retaining underwriting profits and investment income. This allows those within the captive to share costs within a group fund of industry associations or captive subsidiaries without multi-corporate structures, and consolidate coverage and centralize administrative support.