New Year, New Insurance Options
Interest in alternative insurance solutions, like captives, often peaks when theres general dissatisfaction or lack of traditional market alternatives. The perception of greater freedom and control has been a driver of captive growth during hard market cycles. But, would this alternative solution solve all your past woes?
Here are five factors to consider when looking at captives.
1. Cash Flow - The key difference of a large deductible plan is the pre-funding of expected losses and the loss of cash flow advantage. For those on guaranteed cost (GC) plans the difference will be minimal. Theoretically, accounts with good loss history will have lower standard (pay-in premiums), which should present a cash flow advantage to GC policyholders.
2. Collateral - If you're used to GC plans with total risk transfer, the potential premium variability of a captive will be an issue. You'll also find that potential gaps between paid and maximum premiums will need to be covered by collateral (usually a letter of credit). There's no getting around collateral as it protects the insurer and also member-to-member obligations brought about by risk sharing.
3. Tax Issues and Opportunities - With true risk sharing in a group captive, you may be able to take an accelerated tax deduction on claim reserves. Thus, the whole standard (pay-in) premium may be deductible as on a GC plan, although adjustments to premium need to be considered when they occur. On loss sensitive large deductible plans, you're limited to a deduction on losses paid within the year and fixed expenses, so the captive could present a tax advantage. Keep in mind, however, that any captive tax advantage is really only about timing. In the long-term, the tax effect of premium deductibility will be the same. Single parent captives and larger employers may be able to attain certain tax efficiencies depending on corporate structure, external risk in the captive and certain IRS rulings and interpretations.
4. Control - Today, there are few fronting insurers interested in staffing captives. When interested, they want tight controls on business classifications, client selection as well as underwriting and often insist on providing reinsurance, fronting, claim, managed care and even safety services. Only when the captive has history, size and profitability can you hope to negotiate the component parts for greater control and lower fixed costs.
5. Risk Sharing - The key to obtaining lower fixed costs through group buying power and the aforementioned favorable tax treatment is sharing risk with a minimum number of unrelated entities. How you share risk can be flexible and creative although most groups follow the A (frequency) fund and B (severity) fund model.
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