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What is Captive-as-a-Service?

By The Boost Team on Dec 11, 2023
6 min read
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An insurance captive provides businesses with considerable opportunity - and considerable cost. In this blog, we’ll go over what a captive entity is, the benefits and drawbacks, and what captive-as-a-service brings to the table.

What is a Captive in Insurance?

Before we go into captive-as-a-service, we need to be clear on what a “captive” means in the first place. In insurance, a captive is an insurance entity that a business creates in order to insure risks for itself. Let’s break that down in a few examples.

Captive in Insurance: Selling Insurance From a Captive

Say a large cybersecurity company wants to start selling cyber insurance to its customers. Traditionally, the company would partner with a third party like a carrier or an insurance-as-a-service provider to offer the partner’s insurance product. The cybersecurity company could then sell the third party insurance product to its customer base, either under its own brand or as an affiliate. 

In a captive scenario, instead of partnering with a third party, the cybersecurity company would essentially build an insurance company under its control. The cybersecurity firm would be responsible for all the product and regulatory requirements, and would fund the insurance entity with its own capital. It could then sell its own insurance policies to customers, with all the returns - and risks - on its own balance sheets.

Captive in Insurance: Self-Insurance

Companies also sometimes use captives to self-insure against risks to their own business. In this scenario, rather than selling insurance to outside customers, the captive would just provide risk protection to the business that owned it.

For example, a ride-sharing business might want to provide insurance coverage to its drivers in case they’re in an accident while working. The ride-share business could work with a third-party insurer to create the product, but the insurer might not be willing to offer the coverage at a price point that works for the ride-share company (or, the coverage might not be something the insurer wants to offer at all). Creating a captive entity to provide the insurance for itself would allow the ride-share company to build the exact coverage it needs for its business goals. 

What are the Benefits of Captives in Insurance?

There are a number of reasons a business might want to create an insurance captive:

  • Cost effectiveness vs procuring capacity from a third party. Businesses considering using a captive to self-insure likely know that relying completely on third party capacity can add considerable overhead cost to the price of coverage. A captive allows the business to avoid unnecessary fees.

  • Better data visibility. Working with a third-party insurer often means being dependent on the third party for access to important data, including claims information. While some partners may make data promptly available, others may lag by weeks (or months). Since a captive is owned by the business that creates it, the business has more immediate access to all relevant data.

  • Better risk control. Getting more access to data also means being more able to use that data in decisionmaking. Captive owners can therefore more easily use data insights to improve risk assessment and help make programs more profitable over time.

  • Positive signals to reinsurers. The insurance industry is traditionally slow to change, and risk capital providers (like carriers and reinsurers) may be reluctant to provide capacity for unproven products or emerging risks. If a business provides its own risk capital through a captive, it’s a vote of confidence that it truly believes the product and underwriting are sound. This can in turn make other reinsurers more comfortable with putting their money behind it as well. 

  • Freedom to build new or custom coverages. The potential difficulty of securing capacity for new or niche products has traditionally been a significant barrier to insurance innovation. It’s difficult to launch an insurance product without risk capital backing, and so a lack of interest from reinsurers can be a death knell for an innovative idea. With a captive, businesses can self-fund new coverages, offering a path to market for products that address new, emerging, or otherwise difficult-to-place risks.

What are the Drawbacks of Captives in Insurance?

While there are many benefits to creating an insurance captive, there are also some potential downsides to be aware of:

  • High capital requirements. While the ability to self-fund insurance programs is a benefit of owning a captive, the amount of capital required to actually do that is often significant. While exact requirements vary considerably by program and domicile, funding a captive generally means committing significant finances into a trust.  

  • Complex, onerous setup. The insurance industry has a well-earned reputation for regulatory and operational complexity, and setting up a captive is no exception. The owner will need to undertake a feasibility study to determine if the idea is workable and prudent for the company in question, utilize stress testing exercises to provide a glimpse into the range of likely financial outcomes, and provide anything required by the domicile-specific Department of Insurance to ensure the validity and stability of the captive arrangement. This setup process can potentially last more than a year before the captive is approved and the company is able to start participating in business.

  • Significant ongoing operational requirements. Spinning up the captive, while a large task, is only the beginning. The freedoms and benefits that a captive supplies also come with major responsibilities which the state-level DOIs (rightly) take very seriously. Captive owners must take on a range of compliance tasks, including but not limited to production of annual actuarial reports on the health of the business, regular audits, and yearly meetings with the DOI.

  • Increased risk on the balance sheet. Self-funding insurance programs mean that while a business can participate in underwriting profits, it also participates in the losses in the event of adverse experience. Before deciding to embark on creating a captive, businesses should be fully aware of the risk, and think carefully about how they will respond not just to potentially positive returns, but potentially adverse returns as well.

What is Captive-as-a-Service?

Captive-as-a-service offers a mechanism to access the benefits of owning a captive, at far lower capital and operating costs. 

To create such an offering, a captive-as-a-service provider must first go through the full process of creating a captive insurance entity, like we discussed above. After this captive is approved, instead of simply using it to insure their own risks, they are able to rent out “cells” within their captive (provided this structure has been applied for and approved) that other businesses can use.

Thanks to this structure, if a business wants to utilize a captive, rather than constructing an entire captive entity from scratch, they can simply rent a cell from the captive-as-a-service partner. The partner will then handle negotiations with the relevant DOI to work through approval of the cell and determine how it needs to be capitalized. 

The business can then put risk capital into the cell, and use it to run their captive business. Since the cell is part of the larger captive-as-a-service entity, however, the ongoing operational management will be handled by the partner.

What are the Benefits of Captive-as-a-Service?

Captive-as-a-service makes captives more accessible to a wider range of businesses:

  • Dramatically simpler, more cost-effective setup. Most of the structural and regulatory requirements are handled by the captive-as-a-service partner, leaving businesses free to focus on their core mission. 

  • Lower premium requirements. Given the costs involved in setting up a single-parent captive entity, it requires a fairly high volume of premium (often close to $2M) to be truly worthwhile. The much lower costs of captive-as-a-service allow businesses with lower premium income to profitably participate.

  • Streamlined operating management. The cell’s ongoing regulatory and operating requirements are managed by the captive-as-a-service partner, including financial statement preparation, audits, actuarial analysis, and annual in-person board meetings. This translates into drastically lower operating expenses for the business renting the cell, compared to managing a full captive entity.

Insurance captives offer a significant opportunity for businesses to increase revenue, improve risk management, develop innovative new coverages, and more - but they also come with significant costs attached. Captive-as-a-service allows businesses to take advantage of the same benefits as a captive entity, for a fraction of the capital and operating expenses.

Contact us to learn more about building your captive-as-a-service offering on Boost Re.

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