A captive insurance company is an entity controlled by another business, where the captive bears some or all of the insured employee benefit risks of the controlling entity. This arrangement is used so that the controlling organization can save somewhere in the range of 5% to 10% on its benefit costs.
The savings generated by this arrangement come from eliminating the profits that would normally be collected by a third-party benefits insurance firm. Also, the business will become more interested in reducing its loss experience, since the captive will be essentially paying for all claims incurred. Offsetting these benefits is the cost of the arrangement, which involves at least $100,000 to create, and at least $50,000 to operate per year. Given these costs, net savings from the arrangement will only accrue to larger organizations.
There are several requirements to operate a captive insurance company, which include:
- The entity must have audited financial statements
- The entity must be fronted by an insurance entity that has a current "A" rating
- The entity must be licensed within one of the states of the United States
- The Department of Labor must issue the entity an exemption from certain clauses of the ERISA legislation
The captive may hand off some of the risk of loss by purchasing reinsurance from a third party. When a business takes this approach, it usually has an insurance company administer its insurance claims, with reimbursement coming from the captive insurance company.