Captives - Be Informed and Beware

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Occasionally, we are asked by a PEO client or prospect regarding the utilization of a Captive structure to provide workers’ compensation coverage. Before addressing this question specifically, some background information is probably necessary to gain a better understanding of this financing mechanism. Many may think Captives are cheaper and allow greater flexibility with underwriting risks.  Most of the time, Captives are not cheaper and will not allow the PEO to write any risk they desire as it pertains to PEO.  

What Are Captives? 

Captives, or Captive insurance companies, are established for the sole purpose of alternatively financing the risk assumed by a business.  The International Risk Management Institute (“IRMI”) states the following:  “A captive insurance company is an entity created to insure the exposures of its founding organization(s), reduce frictional costs, provide and arrange tailored risk management services, and take advantage of certain tax opportunities.” There are many different types of Captive insurers but those that would directly align with a PEO are a Single Owner Captive, Group Captive, or Rent-a-Captive.  The significant difference with each ultimately is driven by ownership of the Captive and risk tolerance.  Please contact Stonehenge Insurance Solutions if you would like additional information of utilization or structure of Captive insurance companies. 

The PEO industry has had multiple experiences throughout our history with the utilization of Captive insurance companies, most with adverse results.  Why? The presumption by most PEO risk managers is that a Captive allows the writing of virtually any client, the program costs could be cheaper, and cash flow (funding of losses) potentially more attractive.  What many fail to remember is that the Captive is not an admitted carrier and will require an admitted carrier to front the captive program to extend coverage nationally. This is where Zurich, AIG, Fireman’s Fund, State National, AmTrust and any other admitted fronting carriers come into play.  These carriers are going to dictate terms and conditions including collateral and underwriting appetite.  So, with the additional frictional costs of owning all or part of a Captive insurance company, the PEO is back to square one with the features that it deems most attractive.  

I am not in a Captive, what do I care? 

The fact is historically there have been and continue to be PEO workers’ compensation insurance programs that were/are structured as guaranteed cost financing programs for filing purposes. These programs actually house a Captive insurance carrier as a re-insurance layer behind the fronting carrier.  So, why do I care and what are my risks? It is imperative that your insurance professional, agent or broker, have significant experience in managing captive programs.  Additionally, it is also critical that a legal professional evaluate all workers’ compensation documents but especially any that address ownership or membership in a Captive insurance company.  

Top PEO Concerns Regarding Captives 

There are two significant concerns that every PEO must weigh when evaluating any Captive solution.  First, in any group Captive scenario, the single biggest concern is “Joint & Severable” liability.  Essentially, the deepest pocket or last individual standing is responsible for the overall debt of the Captive.  This was a major consideration with the Waterford captive, circa 2001. All assets, including collateral and surplus were consolidated to pay the overall debts of the Captive.  So, all Captive participants may share in the liability for all of its participants.  

Secondarily, there are tax implications with the payment of premium for workers’ compensation losses into the Captive.  The desire is to accelerate that tax deduction of loss payments. Basically, premiums are deducted in the year that they are paid versus payments for loss expense, which are only deductible as the carrier makes claim payments.  The IRS determination as to whether a loss fund payment is deductible in the current year or subsequent years could have a material impact on tax strategy. Those that investigate the details typically remain insured with a standard carrier that is truly fully insured.  

A Critical Question for PEOs

The following question should be responded to in writing from the captive insurer, fronting carrier, program manager and insurance agent or broker.  

Do I as a Named Insured in this program have any known or unknown financial exposures beyond the payment of premiums for fixed costs and claim funding?  

The intent of this brief article is simply to raise awareness or ask questions.  While not suggesting Captives are a poor alternative, we are simply encouraging you to ask questions.  Read the documents you are asked to sign and don’t be afraid to ask questions.  

Contact Us for More Information 

Please feel free to contact Troy or myself with any questions.  We won’t charge you a dime and it might be the most worthwhile call you will make.