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You probably have traditional commercial insurance. But when it comes to protecting your business against a myriad of outside threats in today’s complex and ever-changing environment, is traditional insurance enough — or even the right solution?
With the insurance market getting tougher and premiums expensive, it’s a timely question, especially as more businesses look to other risk transfers. And an increasingly trending option is captive insurance, as globally more than 100 captives were formed last year, as Business Insider reports.
Related: 4 ways to protect your business against inflation
Context of traditional and captive insurance
Traditional insurance has built a portfolio of offerings and coverage options for businesses. Some components of traditional insurance include risk spreading, premium tax deductions, and many general insurance coverages such as general liability insurance, business income insurance, and accident insurance work.
Captive Insurance is a wholly owned subsidiary that exists to protect your business from unique threats and provide the dynamic, unique plan your business needs. Captive insurance may be right for your business if it cannot get the insurance coverage it needs in the traditional insurance market.
For example, business interruption insurance is coverage that protects your business from disasters such as floods and earthquakes. This coverage does not, however, protect businesses against fire or tornadoes – and to activate this insurance, there must be an event that “triggers” your policy.
Businesses that closed during the pandemic lost money while they were closed, and they had to be completely closed to trigger their business interruption policies. With captive insurance, however, businesses can access their stored cash reserves and cover losses during extended partial outages that are not covered by a traditional insurance policy. Unlike this policy language with its many coverage exclusions, captive policy language is designed to protect the business owner.
Captive insurance also does not penalize bad behavior by other companies, and the cost you pay for insurance is not based on claims filed by other similar companies. Other considerations for possibly moving away from traditional insurance are tighter premiums and companies looking to have cheaper coverage.
With this in mind, companies looking to gain more control over their current insurance coverages and programs can build a bespoke insurance plan built around their company’s unique risk profile with their captive plan.
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Bounties are not a sunk cost with captives
High premiums with traditional insurers can subject your business to higher monthly rates and leave your business feeling the impact of these high expenses. With captive insurance, however, your business can retain profits when claims go unpaid.
These retained earnings also see the deferral of taxes on loss reserves, allowing for the accumulation of a larger pool of funds for investment or unforeseen financially impacting situations such as litigation. These funds can also be used to protect your business against losses in the event of an economic downturn or difficult tax situations.
For a small business, this can help with scalability, as the expensive premiums paid with traditional providers can mean less money spent growing your business. Plus, as your business grows in size and needs, the coverages needed to keep your business properly protected also increase. By comparison, Kiplinger pointed out that captive insurance can provide those necessary adaptive coverages as the need arises.
Related: 5 Considerations for Captive Insurance Trends for 2022
Policy Differences and FAQs
If your business faces potential cyberattacks, medical malpractice lawsuits, and many other costly risks, the deductibles associated with these protections increase with traditional providers. Cyber insurance premiums increased by 50% and 100%.
Going back to the previous example, flexibility in the wording of captive insurance policies would be helpful. As evidenced by the 2020 civil unrest, in which parts of the country saw protests, riots and sit-ins that destroyed neighborhoods. If the area around a business was damaged and inaccessible, but the business itself was not, again the traditional insurance policy would not be triggered, meaning your business may have to pay out of pocket.
Related: 5 Ways to Protect Your Business Against Cyberattacks
So how long does it take to create a new policy?
With constant changes in what businesses need in their insurance coverage, traditional insurers can often lag behind. When new threats emerge, it also means new policies need to be developed to cover vulnerable parts of your business.
According to Deloitte, traditional insurance takes 12 to 18 months to create and launch new insurance products. Given the speed at which threats arise and can potentially harm your business, this delay is not acceptable.
Additionally, when purchasing traditional insurance coverage, start-up costs are limited to the premium. However, starting a captive insurance company requires start-up costs and capitalization requirements with incorporation costs including legal fees. Indeed, a captive insurance company is a legally constituted company. Additionally, with captive insurance, you rely on your risk mitigation strategies to build up funds in the event of potential losses.
Although forming a captive can be daunting for a non-insurance professional, there are many captive management companies that will serve as the front office of insurance for business owners, which will help businesses to form and manage their own wholly-owned captives.
Captive insurance can be a viable option for businesses large and small. The companies best served by the establishment of captive insurance are those that have risks that are complex, evolving, difficult or expensive to insure through traditional plans and those that would benefit from increased cash flow, liquidity and profitability. Traditional insurance and captive insurance both have distinct characteristics and one is not necessarily better suited than the other. No matter what you choose, protecting your business with the right insurance plan is a necessity.