Welcome to the fifth installment of our Group Captives 101 series. In this post, we’ll cover the difference between self-insurance and group captive insurance. If you missed any of the previous articles in the series, you can find them here.
When it comes to risk financing strategies, there are numerous options companies can deploy to protect themselves against losses. In this post, we will focus on two of them: self-insurance and group captive insurance.
The two are actually similar — in fact, group captive insurance is a form of self-insurance — but there are significant differences. To help you better understand the distinction, we put together a quick guide on these two prominent risk financing strategies.
Before we dive into self-insurance, it’s helpful to quickly recap conventional commercial insurance (i.e., guaranteed-cost insurance). Perhaps the most commonly known risk financing method, the conventional commercial insurance arrangement involves a company (i.e., the insured) paying a premium to an insurance carrier. In exchange, the carrier agrees to cover specified risks.
It’s a relatively simple arrangement, but conventional commercial insurance has its pitfalls. Insureds have little, if any, control over their insurance program. Instead, they rely on the insurer to define and price coverage, administer claims, and provide support services. And commercial insurance carriers are typically for-profit entities that make money by charging premiums in excess of expected losses and by retaining any investment income earned on loss reserves.
Self-funded insurance (i.e., self-insurance) can be an effective risk management vehicle for companies looking for more control over their insurance program and its costs. By self-insuring, a company typically assumes significant risk rather than transferring it to an insurance carrier.
There are several ways to design a self-funded plan, but in its basic form, a company might set aside funds earmarked for losses throughout the year. The company will also need to dedicate resources (whether it’s hiring an internal team or outsourcing to external professionals) to manage day-to-day functions like actuarial services (e.g., to determine appropriate funding levels), claims management, legal, and other support services.
Self-insurance comes with a few significant benefits for companies, including:
But there are drawbacks. Losses can fluctuate significantly from year to year, making it very unpredictable and expensive for a company to completely self-fund. Self-insurance can also leave companies vulnerable to catastrophic losses (especially without excess insurance). For these reasons, self-insurance is typically reserved for organizations with pockets deep enough to either absorb or insure catastrophic losses and with the resources to manage the program.
Now that we’ve seen essentially how self-insurance works, let’s compare it to group captive insurance. A group captive insurance company is an insurance company owned and controlled by the companies it insures. This arrangement allows mid-market businesses to share risk and collaborate with like-minded organizations as equal shareholders in their own insurance company.
Like self-insurance, group captives offer companies more control over their insurance program and similar advantages as those listed above. But group captives and self-insurance differ in many ways, including how program structure and loss funding.
(Note: there are several ways to structure and manage a captive insurance program, so this explanation doesn’t necessarily apply to all captives. Like our other Group Captives 101 articles, this post will focus on the group captives that we support.)
In the context of this article, a simple way to think about group captive insurance is as a more formalized version of self-insurance. Group captives often engage consultants and managers — e.g., Captive Resources and our sister company Kensington Management Group, respectively — to oversee, coordinate, and administer day-to-day insurance operations. This structure makes group captives more accessible to mid-market companies without the time, expertise, or resources to handle vital insurance functions independently.
Like self-insurance programs, group captives assume a specified level of risk, typically the first layer (e.g., losses from $0 to $500,000) where there is greater frequency and therefore, predictability and transfer catastrophic losses to an insurance carrier. However, group captives also incorporate risk sharing among members for severity losses.
The assumption here is that group captive members will essentially cover one another. So, in a given year, your company might incur a very large loss, and your fellow members will be there to help via this risk sharing component. In another year, your company, along with all fellow members, may help cover the large loss of another member. This is not unlike a conventional insurance program where insureds share risk with other companies, but there are two significant differences in a group captive:
Group captives transfer a portion of the most expensive losses (e.g., $500,001 to $1 million) to an insurance carrier via reinsurance. The group captives we work with also incorporate a variety of mechanisms to ensure adequate funding and protection against catastrophic and aggregate losses alike.
This is a very high-level overview of how the group captive model works. Check out our page on our Risk-Reward Model for more detail on how group captives fund losses.
As we’ve seen, there are a lot of similarities between self-insurance and group captives — most notably, the enhanced control each arrangement provides compared to conventional programs — as well as some significant differences. If you want to find out if group captive insurance is right for your company, contact Captive Resources today to talk to one of our experts.
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