Future of Risk: Captives Take Hold in Mid-market Companies

Captives—single or group owned self-insured companies—are gaining popularity with mid-market organizations as commercial insurance headwinds increase. Health care costs, nuclear verdicts, cyber-attacks, catastrophic climate events, and market-specific drivers are leading to sky-high premiums, prohibitive exclusions, and even complete lack of insurability as reinsurance dries up. Closely held, well-run mid-market companies can navigate around these headwinds by adopting captives as part of their risk management strategy. 

To illustrate, a trucking company has strict health and safety programs in place along with regular driver training and monitoring. The company enjoys a stellar driver record yet, because of the overall trucking industry prevalence of distracted driving accidents and resulting litigation, the company is challenged with securing suitable insurance at a reasonable cost. 

Captives are a viable option for companies like this.  The company is willing to assume more risk because of their positive safety record. A captive allows the business to take on a portion of the risk and through the captive, pay the premium to themselves. As the company maintains its clean record, they create a surplus in their own safety net. That allows them to take on more and more risk over time, while also getting tax benefits.  

COVID catapulted captives to the mid-market risk management arsenal

The COVID pandemic accelerated mid-market companies’ awareness and demand for captives. Many learned the hard way their property insurance with business interruption coverage had communicable disease exclusions or there had to be property damages to make a claim.

This caused business leaders to take a closer look at captives to help protect them from the next global issue. Once they understood the role of captives in that scenario, they started to see the other enterprise risks they can effectively manage through captives. 

A mid-market captive is a Swiss Army knife, not a silver bullet

Mid-market companies are looking at captives as a Swiss Army knife—a tool with a lot of utility. Captives are not a silver bullet that magically and immediately cut costs. Rather, they are an elegant tool that meets a variety of long-term risk management needs.

They give organizations the ability to toggle risk up or down, effectively managing the ebbs and flows of the commercial insurance market. They are in the driver’s seat to buffer the fluctuations inherent in insurance and reinsurance.

Captives can augment a commercial policy’s gaps and exclusions. A captive ensures anything that slips past that primary commercial policy is covered. In this case, a captive is a backstop tool.

Captives can be used for a specific risk area, such as supply chain disruptions, where premiums are high and exclusions abound.

Growth areas for mid-market captives

We are seeing mid-market organizations increasingly adopt captive strategies in these three areas.

Group captives: Like-minded employers pool their resources to establish and manage their own insurance entities. These businesses will have similar risk profiles and risk management approaches and are able to spread the risk among all participants, reducing their exposure. Group captives make sense for numerous mid-market industries—from trucking companies to wineries to manufacturing—as they may not have the financial and administrative resources they need to set up single captives.

Employee benefits captives: Many businesses believe they have no alternative outside the traditional market when it comes to offering group medical benefits.  Or they think that making a change to self-funding is complicated and risky.  Because of these reasons, they stay with traditional health insurance companies and accept double-digit cost increases each year.  

At times, it can often be difficult for mid-size companies to find cost-effective medical stop loss coverage.  A proven approach to overcoming this hurdle is to join a medical stop loss group captive or form a single parent captive.  Both structures help bridge the gap between what employers need to manage risk and what the market is willing to offer in terms of coverage.  In addition to providing capacity, captives offer additional savings through dividends paid from underwriting profits. 

Excess liability captives: Excess liability insurance is becoming increasingly difficult to secure at a reasonable cost if it can be secured at all. Catastrophic losses from climate change-fueled natural disasters, nuclear verdicts, and third-party litigation costs are making commercial insurers shy away in this hard market. Captives can fill the void to manage unexpected risk.

The future for captives for mid-market companies

Brokers will start to embrace captives and recommend them to clients rather than worry about how that may affect business (and their commissions). The more mid-market businesses learn about alternative insurance like captives, the more they will expect brokers to offer them as part of the risk management strategy. Brokers will be wise to proactively recommend captives as part of the risk management strategy.

Captives will spur innovation and new products in the insurance marketplace —for example, cyber liability insurance initially came out of the captive space. Where group captives take hold, there will be greater stabilization of the insurance market, as risk will not be held entirely by the commercial carriers.

Captives’ adoption in certain lines like cyber-attack insurance will slow as rates, premiums, and terms improve in the commercial space. Fewer organizations will use captives to fund these lines, but they will shift captive coverage to other areas.

In sum, more companies will be reaching for their captives Swiss Army knife to help them manage risk.

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