Why would a company build its own insurance? A risk is an ever-present worry of any business owner. A multitude of factors can sink a business operation. Internal and external threats are sometimes the least of the company’s concerns. In some occasions, what can harm the company the most is the company itself.
As any captive insurance attorney might tell you, it’s all about agency. Agency allows the company to act to external factors instead of reacting to them, which gives it an advantage over its competitors and allows them to manage risks.
That is why captive insurance exists. By taking all the risk on their own, a company can scale up, scale back, change, expand, or otherwise be in full control of their own insurance plans, and can account for a greater variety of risk. And knowing the types of risks that they face is the first step to mitigating or avoiding the damages — the first aim of a company’s risk management strategy.
So how does captive management play an active role?
Captive management is when a company effectively creates its own insurance company to protect itself from external and internal risks. This is done by setting aside a significant portion of the company’s capital at the start of accounting in order to protect their operations and can be as constant or as fluid as the company desires.
This insurance amount (and the amount set aside to handle company risk) can change with the performance of the company. If profits are good, it allows the company to extend coverage; if profits are down, it gives the company viable alternatives to shutting down coverage.
But why would a company do this at all?
It’s definitely easier to get a third-party insurer to account for the potential risks of a company. Not only does it allow them to operate without spending their own capital, but the insurance company would most likely take care of all other affairs concerning paperwork and technicalities without the company’s involvement.
However, since insurance companies operate within a certain set of guidelines, that can make their services quite limited to a company that needs something more. Not all companies can operate in the same way, and employment demographics differ from industry to industry, leading to a need to have a more flexible option for some institutions.
In addition, insurance rates are often very prone to shift without the insured company knowing about it. There’s a variety of factors, such as inflation, increased activity within their industry, or a risk report compiled by the insurance company that can raise premiums. This is good for companies that can afford such a shift but can be disastrous for smaller ones that don’t have the resources to adapt.
While it’s a more difficult and uncommon setup, captive insurance can work for companies that need a little more flexibility without sacrificing their agency and risk management. Giving themselves the capability to decide for their own risks and determine how to avoid them allows a company to be more empowered in making important decisions.
If successful, a captive insurance system can help a company stay afloat during times of crisis and become a reliable safety net when it comes to its operations for years to come.
