Is the Captive Agency Model Right for You?

Once the preserve of Fortune 500 firms, captive insurance has increasingly become an important strategic tool for midsize companies as well—especially because exposure to risks like cyberattack or reputational damage is not dictated by the size of the victim.

As risks and needs become more sophisticated, alternative mechanisms for dealing with them evolve accordingly. Today, more than 6,500 captive insurance companies write more than $50 billion in annual premiums—and many of them insure middle-market companies.

For an independent agency, therein lies opportunity.

Captives have achieved popularity among independent agents partially because of the relative scarcity of products appropriate for new and emerging risk sources. Even in more traditional areas like workers compensation, the recent trend is toward some degree of self-insurance.

By establishing a captive, which can provide coverage for workers compensation deductible reimbursement as well as deductible reimbursement for other coverage lines, even midsize companies can reap the benefits from owning and operating a small insurance company—including tax advantages.

One objective of a captive could be to insure risks in categories for which demand is rising, but no carrier exists. It’s in the best interest of the agent to help their clients evaluate and quantify those risks, and establishing a captive may be the best option for transferring the risks they identify.

This strategy ensures funds are available to respond in the event that risk becomes reality, all while the company is able to deduct premiums. In addition, the underwriting profit for a small insurance company is not taxed until it is taken out in the form of dividends or capital gains. The owners enjoy dual advantages of participating in the risk while simultaneously turning risk to profit.

The rise of enterprise risk captives among midsize companies is partially attributable to a provision of the Internal Revenue Code known as the 831(b) election, which allows a captive to elect to be taxed on its investment income only—as long as annual premiums collected do not exceed $2.2 million, the current limit for 2017, which will be indexed for inflation in subsequent years.

Consider a company that has elected a $250,000 deductible for its workers compensation policy. By setting up a captive to cover the deductible and take advantage of the 831(b) election, carriers still handle claims while principals retain the underwriting profit, which remains in the captive and is not taxed until taken out in the form of dividends or capital gains.

For niche business owners in particular, small group captives offer two main advantages: greater flexibility of coverage, and the ability to reduce costs, participate in profits and have access to reinsurance.

Typically, a niche market may have a risk for which coverage is difficult to obtain, particularly at a competitive rate. Setting up a small group captive for the niche market or association may entail a relationship with a single carrier for the entire book of business. The agency could own the captive and enjoy financial benefits beyond just collecting commission or could set up a joint ownership structure for the captive.

Captives are remarkably adaptable to a fast-changing economy. They offer flexibility in coverage and personalized programs for various types of customers. Independent agents should be cognizant of the opportunities captives offer in navigating a constantly changing world of risk.

Jeff Ellington, vice president, Atlas Insurance Management, is a successful insurance professional with more than 30 years of combined experience. He has worked in multiple facets of the commercial insurance industry, including sales, marketing, underwriting and management.