How to Set Up a Captive Insurance Company
Are you wondering how to set up a captive insurance company? First, congratulations on your decision to take control of your company’s risks! While there are any number of reasons to set up a captive, let’s assume you’re already sold on the model and just want some information on how to get started.
#1 Choose Your Domicile
Remember, your captive is actually an insurance company. You wouldn’t ever issue an insurance policy without getting a license, right? If you do, then the long arm of the law will want to have a few words with you. This decision is very important. Different domiciles have remarkably different rules with regard to initial capital with which to fund the captive, how those funds may be invested, and what kind of audit and reporting requirements exist. Some domiciles will audit your captive once every 5 years, some audit more frequently. Offshore domiciles may require you to use local accountants, attorneys, or other professionals in order to conduct business. Some domiciles do not even have legislation relating to captive insurance! Do your homework here before reaching out to the insurance commissioner.
#2 Apply for a License
If you thought getting a driver’s license was a time consuming process, you haven’t seen anything yet. You’ll need to prepare 3 names for the captive, produce several years of audited financial statements for each owner of the captive, an actuary’s report justifying the premium charged by the captive, a 5 year pro forma, a business plan, a color copy of your passport, a utility bill, and fill in a litany of documents.
While time intensive, the application is actually very simple. Just pretend you’re playing a game of gopher with the insurance department. Go for this. Go for that. The insurance commissioner needs to see that you’re a financial responsible individual with a track record of operating a business.
What can hold you up here?
Any bankruptcies or poor credit decisions may preclude you from being licensed to own a captive insurance company. We have seen people who were directors for financial organizations that went bankrupt over a decade ago be denied the right to secure a license or even serve as a member of the board for the captive. There is good public policy for this. Insurance companies that fail to honor their financial commitments (i.e., they run out of money to pay claims) are subsidized by a state to pay out claims. As such, a domicile has a financial interest in ensuring that only qualified, competent individuals are permitted to operate an insurance company in their jurisdiction.
#3 Run the Company
After reading the rules and regulations for your desired domicile, you then filed an application and disclosed every decision you’ve made since you graduated high school. Now, you have a license granted to you from the commissioner of insurance.
Now you need to issue a policy. There are standardized forms out there so you don’t end up pulling an insurance policy out of thin air. If you are unsure of where to find insurance policies, then you may need to contact a manager to help you run the captive. While an actuary is necessary to help you calculate premium, you’re going to need an underwriter to bind a policy and ensure that you pay claims appropriately. If you have enough claims, you may want to consider enlisting a third party administrator to oversee all of your lawsuits. Larger companies can have hundreds of workers’ compensation suits per year. This routine work is generally best handled by a professional.
Money will accumulate in the captive’s bank account. Some of these funds should be retained for Incurred But Not Reported claims (bad things that happened but the claimant hasn’t lawyered up yet). Some of these funds can be distributed in the form of dividends back to the captive owners. How much do we keep in the captive and how much can we give back to the owners? An accountant with an understanding of statutory accounting is necessary or else your captive may end up under-reserved and at risk for bankruptcy.
In addition, you may want to extend ownership in the captive to outside investors. Unless you took a few classes in mergers and acquisitions, then you will need an attorney with some understanding of corporate law to assist with preparing sale documents.
Now you know how to set up a captive insurance company and, as you can see, it’s a lot of work. Running a captive is even more work and requires a team. The quarterback for this team should generally be a captive manager who you work with to manage the daily issues in the insurance company. Specialists are necessary since captives are highly regulated entities with complex features understood by a minority of the financial community.