Captives and Workers’ Compensation
At the 2017 Business Insurance/CLM Workers’ Compensation Conference a panel discussed using a captive to fund your workers’ compensation program. The panel was:
- Arthur Koritzinsky – Managing Director, Marsh
- James Poerio – Attorney, Poero and Walter
- Robert Davidson – Director of Underwriting and Consulting – ICG Captive
A captive is a legally licensed insurance company with a limited purpose. It insurers the risks of the captive’s owners or companies affiliated with the owners through ownership, management, or control. Risk managers like captives because it gives them complete control over their program limiting the impact that changing insurance rates can have on their program. Many large companies use captives as a tool for insuring their risks. But the opportunity is not just limited to large employers as smaller companies can participate in captives using group captives. Rights now there are around 7,000 licensed captives worldwide.
Single Parent Captives
The benefits of a captive can include:
- Risk management as a profit center.
- Underwriting flexibility.
- Access to the reinsurance marketplace.
- Accountability for pre-loss and post-loss management.
- Accelerated deduction for losses.
- Potential tax advantages.
The downside of captives includes:
- Administrative costs.
- Capitalization requirements.
- Long-term commitment.
- A rare high-dollar event early in the captive existence could cause issues.
- Cash flow.
With a single parent captive, you fund deductibles through the captive. Different lines of coverage can have different deductibles. You can also use the captive to insure losses that may not be insurable in the commercial marketplace. All these different lines of coverage can all flow through the same captive.
Single parent captives have a single owner and the captive insurers the risks associated with that company.
Protected cell captives can have multiple participants but each participant is only responsible for their own losses. Each separate company has their own cell which is segregated from the others.
Regulatory domicile concerns for a captive:
- Rules on capitalization
- Rules on solvency
- Business plan
IRS concerns for a captive:
- Deductibility of premium.
- Parent business purpose.
- Business risk vs insurance risk.
- Taxation of captive.
For tax purposes a captive must follow the basic rules of an insurance company in that there has to be risk, and risk shifting. You cannot simply use a captive to hide money from the IRS. The IRS audits captives to ensure they are meeting the requirements of there being risk and risk shifting.
Some large insurance companies started out as group captives. ACE is the best example of this. They started back in the 1980’s when there was a limited commercial marketplace for certain liability exposures.
Group captives involve several financially unrelated companies joining a captive to be insured by that entity for a variety of risks. Often times group captives are set up for certain industry groups (transportation, retail, etc). The most common group captives cover workers’ compensation, general liability, and commercial auto coverage. Companies participating in a group captive share the risk of all the captive members. If there is profit then all members share in the profit, but if there is adverse loss development all members are at risk of assessment to cover those losses. Ultimately there is a fronting carrier that is responsible if losses in the aggregate or specific claims go over the specified retention. The insurance company is going to require collateral from the members to ensure they do not have to drop down and cover something below their expected attachment point.
Group captives try to focus on superior loss control and claim handling services because the members of the captive benefit from these best-in-class services.
The captive underwriting manager acts just like a carrier underwriter; vetting potential members, developing pricing, adjusting pricing based on loss experience, etc. Often times group captives have an admissions committee where existing members have to approve new members.
The big difference between group captives and self-insured groups is that group captives can cross state lines. They are “fronted” by a carrier that has licensing in multiple states. Self-insured groups are limited to single states because the approval for those groups comes from the states. In addition, there is potential for tax savings with a group captive but not with group self-insurance.