What Is an A-B Captive? Function, Benefits, and Risks

While most independent agents know about captive insurance, their financial structures can be difficult to understand and explain confidently to clients. As an independent agent, how do you describe an A-B captive in a way that makes sense to your clients? How can you make them feel more confident about joining a captive, without seeing the opportunity as a financial headache?

Captive Coalition’s sole purpose is to help independent agents understand all things captive insurance related, whether it’s the types of captives or their financial structures. We have the knowledge to break down complex financial models into simple and digestible concepts for your clients to understand. We want you to understand A-B captives so you can confidently present them as a potential solution to your best clients.

This guide will inform you of what an A-B captive is, how the financial structure works, and how to effectively communicate how they can help your clients.

What is an A-B Captive?

An A-B Captive is a type of group captive that uses a two-fund structure to manage risk. Think of an A-B captive as if you’re splitting funds into two separate “buckets.”

Instead of pooling all premiums into one general account, an A-B Captive divides them into:

• A Fund (Frequency Fund): Covers smaller, more frequent claims.

• B Fund (Severity Fund): Covers larger, less frequent claims.

How Does the Financial Structure of an A-B Captive Work?

An A-B Captive is built around two primary loss funds:

• A Fund (Frequency Fund): This covers routine, lower-cost claims. The goal is to manage small losses effectively and keep costs predictable. If the money in this fund runs out, businesses will likely face an assessment. 
  
  
• B Fund (Severity Fund): This fund is reserved for large, unexpected claims. The captive pools these funds to ensure adequate coverage for severe or catastrophic losses. 

Each business contributes a premium, which is split between these funds based on expected claims activity. If losses are well-managed, businesses can get these unused funds back as underwriting profit. 

What Types of Businesses Benefit Most from an A-B Captive?

A-B Captives work best for businesses that:

• Have a strong balance sheet and can handle potential assessments.
• Want to retain underwriting profit rather than pay it to a traditional insurance carrier. 
• Operate in industries with manageable, predictable claims (e.g., construction, transportation, healthcare, etc.)
• Are committed to risk management and reducing claim frequency.

Do you think that your clients might already qualify for captives? Use our captive assessment tool to see if they’re captive-ready. 

How Do the Frequency and Severity Funds Function?

The A Fund (Frequency Fund) handles claims up to a certain threshold. This is often between $1-$100,000 per claim. If the claims exceed this limit, the B Fund (Severity Fund) kicks in between $100,001-$300,000.

Take a look at this image that goes into how the distribution of reserve funds works within an A-B captive financial structure:

There are three buckets of money in a captive.

1. Each member has their bucket in the form of a premium payment.
   
   
2. The captive as a whole (when you combine all the members).
   
   
3. The fronting/reinsurance carriers. The captive is responsible for the retention, usually $300k for a new captive.  

The actuary determines the loss funds using actuarial science, but they are just figuring out the frequency loss pick (how much A fund money this insured needs to cover expected losses). The balance of the loss funds goes to the B fund.

Here is how it works in practice:

• A business has a slip-and-fall claim that costs $50,000. The A Fund covers this since it falls within the small-loss range.
  
  
• A business experiences a major vehicle accident with a $750,000 claim. The first portion of the claim (up to the A fund limit) comes from the B Fund. If the member doesn’t have the loss funds to cover the claim up to the retention, the other members pay it through risk sharing.

Take a look at this image to see how reserve funds are used for a small business when hit with a frequency claim.

Managing frequency losses is essential. After all, frequency breeds severity. If a business burns through its A Fund allocation too quickly, there will likely be additional assessments. 

What Risks Do Businesses Take on with an A-B Captive?

An A-B Captive comes with more financial responsibility compared to traditional insurance. Your clients should be aware of:

• Potential Assessments: Businesses must contribute more if the frequency fund runs out.

• Risk Sharing: In a group captive, poor risk management by other members can impact everyone. 
  
  
• Higher Initial Capital Requirements: Businesses must contribute collateral, often based on expected losses.

This said, businesses with strong safety programs and financial discipline can benefit from this structure.

How A-B Captives Help Businesses Manage Insurance Costs

A-B Captives provide more cost transparency and control than traditional insurers. Here’s how:

• Retention of Underwriting Profit: Instead of paying a carrier, businesses keep a share of the unused loss fund.

• Reduced Premium Volatility: Market cycles or carrier rate increases do not affect the businesses. The captive doesn’t look at the traditional market at renewal. Only the business owner’s actual loss experience.

• More substantial Incentives for Loss Control: Since businesses directly fund their claims, they are more motivated to prevent losses.

Misunderstandings Agents and Clients Have About A-B Captives

A-B Captives are already difficult for many to wrap their head around, which causes hesitation from both agents and clients. Here are some misunderstandings:

• “A-B Captives are riskier than traditional insurance.”

• In reality, they offer more control but require financial discipline. Proper risk management will minimize exposure. 

• “Captives are all structured the same way.”

• This isn’t true. Every captive works differently. You also have other structures like Quota Share. A-B Captives are one of many options. 

What Independent Agents Should Know Before Recommending an A-B Captive

Independent agents should:

• Understand the financial commitment. Clients need to be comfortable with potential assessments. 

• Educate clients on risk and reward. A-B Captives require more responsibility because the collateral requirements can be large, but the long-term financial upside is significant. 
  
  
• Identify the right candidates. Businesses with poor safety programs or tight cash flow may not be good fits. 

Still not sure what businesses work well for captives? Read our article on what businesses are ideal for captives. 

How Businesses Transition To A-B Captives

Joining an A-B Captive involves: 

• Initial Capital Contribution: Businesses must provide upfront collateral, typically based on expected losses.

• Premium Allocation: A set percentage of premiums is placed in the frequency and severity funds. 

• Claims Management: Businesses actively manage their claims to minimize frequency losses and avoid assessments.
  
  
• Profit Distribution: If losses are controlled, businesses receive a return of unused funds.

While the upfront financial commitment is higher than traditional insurance, your clients have the ability to retain underwriting profit and stabilize long-term costs. 

Would an A-B Captive Structure Work For Your Clients?

A-B Captives provides a structured way for businesses to take control of their insurance costs. However, they also require a solid understanding of risk management and financial responsibility. This model allows companies to retain underwriting profit and reduce premium volatility.

Next, read our article on the timeline for onboarding a client into a captive to understand the step-by-step process in depth. 

Want to learn more about captives? Become a member of Captive Coalition for free to access training, webinars, tools, and resources to help your best clients access captives.