In the construction industry, risk is part of the job. So, insurance isn’t just a precaution; it’s a huge financial consideration. With a hard insurance market and inflation driving up the costs of already expensive Workers’ Comp, Liability, and Auto insurance, your usually thin margins are probably being stretched to the brink. One potential solution many construction companies are increasingly turning to is captive insurance. If you’re unfamiliar, we’ve put together a handy guide below.
To cover all the bases, we’ll explore:
- What is captive insurance?
- What does captive insurance typically cover for construction companies?
- The benefits of captive insurance for the construction industry.
- The potential cons of captive insurance.
- How to figure out if you’re a good fit for captive insurance.
What is Captive Insurance?
A “captive insurance” is an alternative risk finance program that is owned, funded, and operated by the companies it insures – its members. It allows business owners to have a greater control of their insurance program.
Captives can be heterogeneous – with members from different industries, – or homogeneous – with companies from the same industry. You can own a captive by yourself (single cell captive), or with multiple other businesses (group captive). Members are selected based on their established history of Safety and Loss Control practices.
Essentially, at a high level a captive insurance company is an asset you can better control and keep the underwriting profits instead of paying it to a traditional insurance company.
Group Captive Insurance
With a “group captive,” multiple businesses come together to form a collective insurance pool. Each business pays into the pool and uses those funds to cover the losses in the event of a claim up to a pre-set dollar threshold. This model is especially useful for companies that prioritize safety-first culture and control their claims.
Single Cell Captive Insurance
With a “single cell” captive, one business owns its own insurance captive. It pays this entity its premium and then covers its claims. By doing this, it keeps insurance funds flowing within the business rather than paying an external insurer. The single cell captive model is usually advantageous for companies with large budgets or hyper-specific coverage needs.
Both types of captives offer their owners more control over insurance policies and, as a result, can be more cost-effective than standard insurance.
What Does Captive Insurance for Construction Industry Cover?
Construction captive insurance companies usually focus on covering:
- Workers’ Comp
- Commercial Auto
- General Liability
The Benefits of Captive Insurance for Construction Companies
Captive insurance is particularly beneficial to businesses in the construction industry for the following reasons:
1. Price Stability
Insurance premiums are heavily affected by the national and local markets. If your business operates in a city or state where drivers are reckless, causing auto accidents to be more likely, you will pay higher auto insurance premiums as a result. This means if you have a stellar safety record, you are essentially overpaying to compensate for all the unsafe drivers in your area.
When you join or form a captive, however, you remove yourself from the national and local markets almost entirely. You are now weighed on your own loss history and exposures and not by external market factors you don’t control.
For group captive insurance companies, there are typically also high safety standards for entry. This ensures that your money is pooled amongst businesses that share a similar commitment to reducing accidents and keeping their insurance costs low.
These factors help captives stabilize premiums by removing the volatility of the open market from the equation.
2. Enterprise Risk Management
In the construction industry, you face many risks that other companies never have to worry about. Since these risks are rare, insurance companies find them more difficult to predict. As a result, they hike up the cost to cover them to offset this uncertainty.
But with captive insurance, you are no longer stuck with a one-size-fits-all solution. Since you control your policies, claims handling, and loss prevention strategies, you can better customize your insurance. This can lead to a significant cost reduction over time.
3. Maximized Returns
One of the primary ways traditional insurance companies make money is by taking the money you pay in premiums and reinvesting it.
When you form or join a captive insurance company; however, your premium payments now go to your captive you own, not a third-party insurance carrier. This allows those funds to be used similarly but for the benefit of captive members.
The models vary depending on the way your captive structures them, but two main ways businesses benefit from this are:
- Premium Investments: Many captives develop impressive reinvestment strategies that provide significant returns to their members over time. This reinvestment can generate additional income, turning a cost into a potential profit center.
- Distributions: In some captives, if claims are lower than expected and the captive has accumulated profits, these profits are then returned to the stakeholders in the form of a distribution.
Additional Considerations
Despite the attractive benefits captive insurance offers, there are a few potential downsides to consider as well:
1. Collateral Requirement
To form or join a captive, a collateral requirement is typically necessary, which protects the captive members in the event a member goes out of business or leaves the captive. This upfront financial commitment can tie up your cashflow initially.
2. Shared Decision Making
Being part of a captive also means sharing decision-making responsibilities with other members. Major decisions made within a captive are often subject to group votes, so you won’t always have the final say in specific policies or changes.
3. Assessment Fees
In the captive insurance system, where premiums are optimized through shared responsibility, each member’s claim history directly impacts the group’s overall costs. Should you file more claims than anticipated or have a major incident that exceeds the funds you’ve invested, you could be charged an “assessment” at the end of the year to help balance those unexpected expenses.
How to Figure Out If You’re a Good Fit for Captive Insurance
The main requirement for joining an existing captive is a strong safety record. This is vital because it demonstrates that you are less likely to file claims. Minimal claims keep the captive’s costs down, ensure the stability of the pool, and help the chances that there will be financial benefits for all members.
Ideally, you should have a record of minimal losses over the past five years. If you have a loss ratio (the percentage of claims paid compared to premiums earned) of around 40%, you could be a good fit for captive insurance.
You’ll also need the funds to cover the initial collateral payments required to join.
If you think you might meet these benchmarks and want to explore the idea of joining a group captive insurance company, don’t hesitate to get in touch. Our in-house risk control team can help evaluate your loss history and determine whether you are an immediate fit, or, if not, help you get on the path to potentially qualifying down the road.
Contact Dan McCarthy at dmccarthy@hilbgroup.com to get started today.
To check out a few of our results achieved for some of our clients in a captive and to learn more, click here.