I’m a person that has worked with businesses of varying sizes for many years now. I’m used to hearing about financial and business jargon on a daily basis.
Although I heard about it before, I was never too sure what captive insurance was all about.
I had assumed that it was some form of insurance for large companies, but I didn’t know which risks got mitigated with it.
Well, I was partly right; it is a form of insurance for the bigger corporations out there.
Simply put, captive insurance is a form of self-insurance. It involves setting up a new company that’s part of a group, and it manages that group’s risks.
But, how exactly do captive insurance companies work? And why is it essential for the larger businesses out there?
I decided to do some research on the topic. Here’s what I found out.
They keep safe large sums of money
One interesting way to look at captive insurance companies is that they are like banks, keeping safe vast amounts of money. Let’s say you have a company that has subsidiary businesses.
A captive insurance company sits alongside them and underneath the parent firm.
The only difference is it has just one function in the tree of companies. It mitigates risk for its brothers, sisters and parent company.
With me so far? Good!
All of the other companies in the group pay their share of money in return for insurance cover.
As you can imagine, all that money goes into a big “vault.”
They can offer various insurance products
Businesses take out insurance cover to transfer varying degrees of risk to a third party. That’s still the case with captive insurance companies, except that the “third party” is just a member of a large family of firms.
Types of insurance cover they can offer include workers compensation and general liability. For example, if you are in California workers’ compensation insurance provides medical expenses, lost wages, and rehabilitation costs to employees who are injured or become ill “in the course and scope” of their job.
It’s up to the other subsidiaries to make sure they don’t do something that causes a potential claim to arise. But, should the need arise, the captive will manage the claim and limit the amount paid out as much as possible.
They can safeguard against other losses
Let’s say that one of the child companies in the group isn’t doing so well. Rather than admit defeat and shut it down, a captive can provide a financial lifeline to it.
For example, let’s assume one of their biggest clients went bust and didn’t pay a significant invoice.
The captive can provide something akin to invoice finance. That way, the child company still has a healthy cash flow, and the captive can chase the liquidators for a share of any money or assets from the defunct customer’s business.
They don’t need a huge investment to set up
By now, you’re perhaps wondering how much it costs to start a new captive insurance company in your group.
You might not realize it, but you only need as little as $250,000!
Yes, that might seem like a lot to some people.
But if you’ve got a multi-million dollar group of companies, each subsidiary’s share isn’t that much.
So, if one of your workers decided to sue you, it won’t be bad enough to put your entire group out of business.