Trucking companies are at inherent operational risks. Captive insurance is an opportunity for fleets to minimize their risks and gain better overall control over their premiums in the process.
Whether or not to join a captive is up to the discretion of the company and if it can meet the requirements of the captive.
What Is a Captive Insurance Company?
A captive insurance company is a complex insurance arrangement with multiple tiers of owners, liabilities and responsibilities. Most captive insurance companies in the trucking industry act similarly to a co-op.
Like any other insurance company, the purpose of a captive insurance company is to insure the owner’s operating risks. As a member, you are deciding to accept a larger deductible (retention amount) per occurrence in hopes of securing consistent pricing over a long period of time and control over the policy’s plan or design.
As a member of a captive, you gain access to a marketplace of “reinsurers” that are willing to insure or “place bets” on specific risks. That’s what gives a captive an advantage.
Here’s how it works:
- Owners or co-owners of a captive pay a standard deductible.
- They own a small insurance company that collects premiums and will pay out on smaller claims.
- Captives purchase reinsurance that will absorb the most catastrophic claims.
- When captives pay out less in claims than they collect in premiums, the surplus will be used as reserves for the insurance company.
- Having healthy reserves allows the captive to buy less reinsurance or return the capital back to the owners.
Captive groups typically allocate 65% of premium dollars to a loss fund to cover claims and 35% to cover operational costs.
There are a few terms to know if you’re interested in captive insurance:
- Single-owner captive insurance companies are also known as “pure” captives. They insure only the risks of the owner or their subsidiary operations.
- Group captives are owned by multiple, non-related organizations and are designed to insure against the risks of these entities.
- A sponsored captive uses capital provided by a reinsurer or insurer while offering “fronted” coverage to entities that are typically unrelated. Sponsored captives can be a licensed insurer, a fronted captive insurer or an authorized reinsurer.
Trucking companies are typically part of a group captive arrangement.
What are the Benefits of Captive Insurance?
There are several benefits of captive insurance programs for trucking companies.
Focus on Safety
Your company may already be focused on safety and investing in safety-related training, but when you become the insurer, you have an even greater incentive to focus on safety.
Captive owners meet regularly to compare accident results, benchmark one another and share best safety practices. Because everyone owns the company collectively, there is a greater incentive to share best practices and keep each other in check to reduce the number of claims filed.
A safer fleet also means lower driver turnover and higher profitability.
One of the most appealing aspects of captives is that they often allow for more stable pricing. Premium increases and negotiations are always a hassle for trucking companies, but captives can often offer better stability when it comes to costs.
It’s important to note, however, that captives must still be run like other insurance companies. Pricing may still fluctuate, or the captive could very well become insolvent. Actuaries must be contracted. The actuaries will set premium rates for the captive and report on the captive’s general health.
Better Cash Flow
Captives do offer the opportunity for better cash flow. If you are fortunate enough to join a captive with other trucking companies that have great claims performance, then there may be a surplus of cash that will be returned to you via:
- Lower premiums in the future
Over time, the captive will accumulate cash (provided the company can keep claims low). A portion of the money can be loaned to the operating company at market rates.
Depending on where the captive was established, there may also be tax benefits for owners.
Premiums that are paid to the captive by the operating company are considered a tax-deductible expense, which reduces tax liability for the operating company.
Risks When Joining a Captive
Trucking companies should know and understand the risks of joining a captive, too. While many risks exist, the following are the most concerning:
Lack of Control
Members of the captive have to put their trust in the broker or manager of the captive. Members put a lot of capital into the captive, but they have very little say as to what happens aside from that.
For example, the person(s) in charge of the captive must have:
- Safety compliance standards in place
- Compliance programs in place
If the management isn’t well-versed in these areas, it can lead to major issues in the future for the captive.
In the ideal world, all members of a captive would properly vet their drivers, maintain strict safety protocols and use the best technology to improve safety. With that said, bad decisions can impact the captive drastically because insurance is certainly a business model that is difficult to maintain.
A larger company’s claims and lack of investment in safety will cause major disruptions for every member, and it’s possible that mitigative action will occur too late to correct these issues.
If caught quickly, remedial action can be taken to rectify issues with captive insurance.
As with any business model, it’s crucial to maintain cash reserves. Captives are not a piggy bank, and there must be cash reserves kept in their coffers. The goal is to keep the insurance company solvent, and if these reserves are depleted, there’s a major risk of insolvency.
With that said, if a business is too risky and has an unusual number of claims, it can cause significant capital concerns and put the captive at risk.
Captive Insurance Requirements
Captive insurance isn’t required in trucking, but they’re often beneficial to join. If you do join one of these insurance companies, you’ll need to know that they’re very difficult to exit. A lot of captive insurance often requires a commitment of 5 or more years to enter one.
If you decide to leave earlier, it may not be possible.
The logic behind this is that everyone in the captive insurance funds each other’s claims and are considered “Insured but Not Reported,” (IBNR). Complex calculations go into determining IBNR for the betterment of everyone involved.
You will also have little control over the day-to-day operations of a captive.
Every member of the captive is vetted intensively to ensure that a single member of the captive isn’t a threat to the others involved. For example, a trucking company may be a significant risk due to its high accident rate.
In this case, the captive may deny membership because there’s too much risk for all of the other members involved.
Trucking companies will also likely need to meet certain income requirements. Generally, companies that generate $1-$2 million in income will qualify to set up a captive.
Here are some other qualifications or requirements that companies may have to meet to join a captive insurance group:
- Having a long-term strategy for risk management and financing.
- Additional collateral
- Exposure to significant loss
- Having predictable insurance losses
Captive Insurance is an alternative to traditional insurance that trucking companies should consider. The arrangement offers quite a few benefits, but the risks cannot be overlooked. Consider the requirements, benefits and commitment required for joining a captive.
Many states now have captive insurance laws, which makes it a little more straightforward to join one.