While captives might be the ideal insurance solution for your best candidates, at least it is until something potentially goes wrong. A bad claims year, unexpected financial struggles, or regulatory changes can all create challenges. Your client won’t call their attorney or reinsurer first. They’ll call you.
Of course, you’ll want to address their concerns confidently. That way, you can maintain trust, credibility, and future business. This is why you want to understand the most common risks your client can face in a captive and how to respond.
By the end of this article, you’ll understand common risks businesses face in a captive and know precisely what to do if something goes wrong. That way you can guide your clients if the worst comes to the worst.
What Can Go Wrong in a Captive?
Look, captives don’t work for all of your clients. You won’t be able to wave a wand and make their risks disappear like magic. They require active management. Businesses can’t get complacent or be negligent with their risk management. That can cause things to go sideways. Here are the biggest risks:
- A Bad Claims Year: Too many large claims can quickly drain reserves, which leads to assessments or increased collateral requirements.
- Financial Struggles: If a business runs into cash flow issues, it may struggle to meet its financial commitments in a captive.
- Regulatory or Market Changes: Your clients could face unexpected challenges if the captive changes its rules or a fronting carrier pulls out.
These situations don’t happen often, but when they do, the businesses that are prepared will fare much better than those that aren’t.
The Obligations of Being in a Captive
One large misconception about captives is that they’re passive or are to be treated as insurers in the traditional market. They’re not. When a business joins a captive, they’re committing to:
- Attending board meetings and participating in governance.
- Engaging in loss control programs to keep claims low.
- Staying financially committed, even in tough years.
If your clients aren’t ready for this level of involvement, they shouldn’t consider captives. Your clients need to understand this upfront.
You might be unsure if a client is ready for captives. Use our captive assessment to see if they would benefit from being in a captive.
What Happens When a Business Has a Bad Claims Year?
Captives thrive on effective risk management. Unfortunately, businesses can have a rough year with claims, which can throw everything off balance. Here’s what to expect:
- Assessments: If the captive doesn’t have enough reserves to cover the losses, members may be required to contribute more money.
- Increased Collateral: Depending on the captive’s structure, the business may need more collateral to ensure future coverage.
- Potential Exit: If the losses are too severe or mismanaged, the business may be asked to leave the captive.
This is why your clients need proactive loss control and claims management. If they’re not taking claims seriously, they could be in for a rude awakening.
What If a Business Struggles Financially?
Captives require ongoing premiums and collateral contributions. If a business hits financial trouble, it’ll need to make some tough decisions.
- They may be forced to exit the captive if they can't pay.
- Collateral funds stay in the captive until all policy years are closed. This typically takes five to seven years.
- Your client can leave a captive at any time without penalty for leaving. However, they won’t get their money back until all claims have been accounted for.
A client’s business in financial distress might not be thinking long-term. Remember, captives are a long-term risk finance strategy. Help them plan so they don’t end up in a situation where they have no options.
External Factors That Can Impact a Captive Insurer
Some risks are outside of your client’s control. These include:
- Regulatory Changes – A captive’s domicile could change its laws, potentially affecting operations.
- Market Shifts – Coverage availability may be impacted if the insurance market tightens.
- Fronting Carrier Issues – Captives can face issues with a fronting carrier that make life difficult for everyone. If a fronting carrier decides to exit, the captive needs to find a new one. This can be a major hurdle.
What’s the best way to avoid or mitigate these risks? Have your clients work with established domiciles and strong fronting partners.
Handling Major Claims That Exceed Reserves
When large claims exceed a captive's reserves, the captive needs to adapt:
- Reserves are adjusted based on new claim data.
- The captive may require additional funding from its members.
- Claims management strategies (like audits, investigations, or surveillance) may come into play to mitigate costs.
While captives are designed to handle risk, members must be financially prepared for fluctuations.
When a Business Needs to Exit a Captive
Sometimes a business needs to leave a captive. Here’s what happens:
- They immediately stop paying into the captive.
- Collateral stays in place until all policy years close.
- Once the policy years close, they receive any remaining distributions.
There aren’t penalties for a client leaving. However, they should plan their exit carefully.
How You Can Help When Something Goes Wrong
Here’s how you can support clients when challenges arise:
- Monitor their claims management process. Encourage proactive loss control to prevent a bad claims year. Bad claims only make things worse.
- Help clients plan for financial commitments. Make sure they understand the potential for assessments and the need for adequate cash reserves.
- Stay informed on captive regulations and market trends. If a fronting carrier exits or a domicile changes its laws, you can help clients pivot quickly.
- Communicate regularly with captive managers. Having a strong relationship with the captive’s leadership can help you get ahead of problems that can come up.
Helping Your Clients Stay in Control
Captives require a long-term commitment and proactive risk management. Thankfully, businesses that understand and manage captives can see lower insurance costs, better risk control, and financial advantages over time.
Captive Coalition’s sole purpose is to educate and help independent agents on all things captive insurance. While we want to say captives are the perfect solution for your clients, not everything on this earth is perfect. We want you to know what can also go wrong with captives.
If you want free access to additional tools, resources, webinars, and training on captives, become a member of Captive Coalition.
