When should I start a Captive?

The short answer to the above question is NOW, but then we are biased because we are selling, not buying.

A more informed answer is that it is all a question of balance sheets. We tell everyone who approaches Hartwell Insurance that everything in Captives is about Balance Sheets, namely the Insurers Balance sheet and that of the client.

To illustrate my point: if an insurer is willing to write a policy for $1,000,000 of liability for a Premium of $1, then the client should most assuredly NOT self insure using a Captive. Why? Because if the insurer is willing to expose their Balance Sheet to a Million Dollar claim for a Premium of $1 then the client should use that Insurer’s Balance Sheet, as it is the most cost effective solution for the client. Why expose your own Balance Sheet when you can use the Balance Sheet of others for little or low cost?

However, if the Insurer is offering that same policy limit of $1 million for a Premium of $500,000 now they are potentially selling their Balance Sheet at a high cost and it might well be a more prudent use of the client’s own financial resources (Balance Sheet) to use a Captive in order to self insure.

The decision to self insure using a Captive very much revolves around risk appetite

So, the decision to self insure using a Captive very much revolves around risk appetite (is the client risk averse or risk friendly) and the ability of the client to fund their own losses by using resources from their own Balance Sheet. Plus are they able to use those resources more cost effectively than standard market Insurers? If the client is accepting $1 million of risk into a Captive but funding it at $500,000 of Premium annually then it can be readily seen that the exposure to the Balance Sheet in the event of a claim would be $500,000 in additional Capital or Premium.

The value of an Insurer, over and above that of a Captive, is almost exclusively in their ability to offer ‘timing risk’ if they issue a Policy for $1 million limit and a premium of $500,000 and a claim of $1 million occurs on Day 2 of the Policy period then the Insurer will pay the full 1 million and will effectively be out of pocket (in that year) by $500,000. When a client uses a Captive then the client is self insuring and is taking the timing risk themselves. However, timing risk is something that diminishes over (you got it) TIME. So in our example – after two years of paying $500,000 for a million Dollar policy there is no more timing risk as the policy is fully funded.

Starting a Captive is all about the ability of the client to accept that timing risk and their ability to fund the timing element more effectively than the Insurance market is offering. Having 100% of your exposures in a Captive is rarely a good idea but so often we see that a blended approach is the most effective solution. Captives make most sense for lower down exposures: ‘Buy Downs’ or Primary Layers they make less sense as you move up the program. Why? Because as you move higher up an Insurance Program Insurers get more relaxed with accepting risk and so they offer terms that are more cost effective and render exposing the client’s balance sheet less worthwhile. 

We never pressure the client to take on too much risk and we offer tailored solutions for big and small clients alike.

Hartwell Insurance is a Captive Insurer that will help explain in detail whether you should or should not insure using a Captive. We never pressure the client to take on too much risk and we offer tailored solutions for big and small clients alike.

Roland Horton

Hartwell Insurance, Nashville TN.