Owning Vs. Renting: Which Is Best For You?
Regardless of the state of the insurance market, captive use has continued to grow, resulting in about 4,500 captives located in more than 100 domiciles. They are a longtime staple of the alternative risk-transfer scene and cover virtually every type of imaginable risk.
Captives are so pervasive, in fact, that most risk managers and insurance buyers have had some tangential experience with them.
But if your company is interested in using a captive, you need to understand the underlying differences between owning your own facility and renting spacea decision that depends on individual circumstances.
Instead of first focusing on the time and capital required to run their own captive, most companies immediately jump to what can be favorable financial consequences of captive ownership.
Unfortunately, there are no meaningful short-term benefits associated with owning a captive versus renting one. In fact, owning a captive over the short term is expensive. Start-up costs alone which don't include the capital investment can be considerable, running to the low six-figures and beyond.
Captive ownership also requires a sophisticated level of financial analysis, risk analysis and understanding far beyond that required to rent capacity from a third party. Added to this is the very real concern of whether the captive is a bona fide insurance company for tax and accounting purposes. You'll need to make sure you have support for your position from a tax expert if you deduct insurance premiums from your federal income taxes.
Remember, "rent" literally means renting another company's capital and capacity, and "own" connotes invested capital and equity. You may not realize it, but owning your own facility puts you in the insurance business. This means you with guidance from outside experts are responsible for all decisions impacting claims handling, loss prevention, excess reinsurance, domestic fronting (if necessary), selecting an actuarial firm for pricing models and reserve certification as well as choosing a captive manager, auditors and attorneys.
With all this in mind, there are significant advantages to captive ownership to consider. One of the most substantial long-term benefits afforded by captive ownership is the very desirable flexibility and versatility it allows. When you form your own captive, you are creating an asset. And like any other corporate asset, it must meet your company's standards.
The most obvious attraction for owning is control. When you rent instead of buy, you typically have to accept the delivery of bundled services, built-in fronting and excess insurance offered by the insurer. You also may be prohibited from retaining alternative service providers such as third party administrators or loss prevention consultants.
Other advantages of owning a captive include immediate reward for reducing losses, fewer regulatory restrictions and an enhanced risk management perspective. If your company is prepared to devote a high level of management and financial resources to the process, captive ownership is for you.
Rental captives, on the other hand, generally provide most of the benefits of owned captives but without the level of time or financial commitment required in captive ownership.
A well-structured rent-a-captive or segregated cell company can match the financial benefits of owned captives and be set up in a fraction of the time days rather than months that it takes to form an owned program.
Rent-a-captives are far more adept than owned captives at solving a short-term problem or addressing an immediate need, like the inability of the conventional insurance market to provide a risk transfer product at a reasonable cost.
They also can produce a current benefit such as certain tax advantages. Although rent-a-captives typically attract companies that want to test-drive the concept before they buy, that trend is changing. In fact, more and more organizations are content to remain a tenant rather than an owner, provided their landlord treats them fairly and delivers the needed products and services.
Although qualitative differences exist between owned and rented captives, their respective benefits are strictly subjective one firm's benefit is another firm's drawback, or as the old saying goes, beauty is in the eye of the beholder. It would be wise to review all circumstances carefully before making a choice.
Donald J. Riggin, CPCU, ARM, is manager of product marketing and planning at Liberty Mutual Captive Services in Boston.
Flag: Did You Know?
Head: How To Boost Captives Value
A typical captive business plan includes lines of coverage that produce predictable outcomes but may or may not meet your companys minimum financial benchmarks. These include primary workers compensation, general liability and, perhaps, auto liability.
An owned captive, however, is not limited to these standard coverages. Under certain circumstances, the type of risk the captive covers can be expanded by:
Ceding selected additional risks beyond the initial business plan.
Assuming risk from lines of insurance that have become prohibitively expensive.
Accepting additional risk in exchange for a reasonable premium when market capacity is restricted or unavailable.
When appropriate, adding these risks to your owned captive can substantially increase its value and possibly reduce premium costs.
Reproduced from National Underwriter Edition, March 4, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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