In one of my favorite films of all time, “The Big Short,” Ryan Gosling’s character Jared Vennet tells the audience that Wall Street professionals often use complicated jargon to describe what they do, so it seems like they’re the only ones that can do it. They try to obfuscate simple truths to make more money. The movie cements the generally accepted principle that Wall St.is a rigged game.
Spoiler Alert: The insurance industry is a lot like Wall Street.
The insurance industry loves to make up complicated terms and appear as if they’re providing excellent value to clients. As a result, traditional insurance carriers and their “independent” broker partners rake in billions of dollars each year from construction companies that need to protect themselves from risks. The simple truth is that many of these companies would be better off using non-traditional insurance to manage that risk.
In this article we are going to uncover why your broker’s interests and your own might not be aligned. Specifically we’ll examine captive insurance and why brokers may be reluctant or unable to recommend captive insurance for workers' compensation, general liability, and auto insurance, despite its potential benefits.
They shouldn't even call it insurance.
They just should call it ''in case shit.''
l give a company some money
in case shit happens.
Now, if shit don't happen,
shouldn't l get my money back?
– Chris Rock
Captive insurance is a form of self-insurance where a single company or a group of companies create a licensed insurance company to provide coverage for themselves. Unlike traditional insurance, captive insurance offers customization and is often more cost-effective in the long term, especially for industries like construction with specific risk profiles.
Unlike traditional insurers, the captive isn’t trying to profit off its policyholders since they are also shareholders of the captive. Profiting off yourself makes no sense. A captive also doesn’t have exposure to the construction industry as a whole like large carriers such as CNA, Travelers, Liberty Mutual, or The Hartford do. It only has to worry about the risks of its small group of owners/policyholders. As a result, the captive can price policies much lower than the traditional market. The companies in the captive also benefit from more predictability. Their premiums don’t swing wildly from year to year except in extraordinary circumstances.
Then, when the companies in the captive manage their businesses well and reduce claims, the insurance company (which they own!) still realizes profits like any good insurer. The profits can be invested and eventually returned to the owners.
There are other numerous benefits to captives and I suggest you review some of our other articles if you want to do a deeper dive.
Here’s the big question: If captives are so awesome, why doesn’t your broker bring them up prior to your next renewal?
The commission structure on traditional insurance policies is a primary factor influencing broker recommendations. On a workers compensation policy, brokers typically make between 8-12% commission. Commercial Auto policies pay around 4%. Other policies like general liability, cyber, and directors & officers, can pay 10-25%.
Let’s look at just one carrier and coverage type to get an idea of how much money is changing hands.
In 2022, one of the largest insurers for the construction industry wrote approximately $3.3 Billion (with a “b”) in workers’ compensation insurance. That would mean that they paid commissions between $267,000,000 and $400,000,000.
It’s also worth noting this carrier states a profit margin across all of their business insurance products of just over 90% for 2022. That’s money that could’ve stayed in your pocket.
A captive isn’t designed to reward brokers for referring their clients. Captives are about pricing policies appropriately for the risk of the client and getting the expenses as low as possible. There are no margins for commissions.
Some captives pay a fixed fee to brokers that refer clients but it’s never as much as a traditional policy would pay. As a result, the broker network inherently favors traditional insurance policies. This is completely at odds with the best interests of tens of thousands of awesome construction companies.
Many brokers don’t understand captive insurance. After all, their livelihood is primarily driven by carrier commissions. They aren't incentivized to spend time learning about other types of insurance.
Carriers aren't helpful either in regards to educating insurance professionals about captives. Why would they be? Captives reduce profits for them. Their bread and butter is traditional insurance policies.
You'll find token references to captives on most insurance carrier and broker websites. But you won't find very many details on costs, formation process, etc. Nor will you find detailed case studies that showcase premium reductions and long term profits.
Most companies will have to spend money finding out if a captive is for them.
At a recent conference on Construction Risk, I quizzed several insurance brokers about captives and out of five brokers present, only one had any knowledge of what a captive was and how they worked.
Advisors tend to advise about what they know. And unless your broker has their own captive option (which we’ll cover in a future article) they may only have superficial knowledge about captives.
Once again, this is an example where your broker's interests are different from yours.
Not all companies are a good fit for a captive. For example, new companies with no established claims or financial history are unlikely to be accepted into a captive and would need to get traditional insurance. Many smaller companies aren’t suitable for a captive either because their premiums aren’t at a level where it makes sense. There are always going to be more of these types of companies than ones that are ideal for a captive.
Brokers might not understand captives but they do understand that maintaining good relationships with their carrier partners is crucial. How would a carrier react if a broker suddenly started removing clients from the traditional insurance ecosystem? Especially if those clients are the ones with significant premiums and low claims history?
Would they start refusing clients the broker brings them? Would they be forced to reduce commissions on certain lines of business? Would they withdraw other incentives that are typically afforded to top producers?
It’s hard to say.
One thing is for sure, the insurance landscape would be considerably shaken if the status quo was challenged.
Companies that move to a captive solution stand to benefit greatly from the switch. For example, a company spending $500,000 combined annually on workers’ compensation, general liability, and auto insurance could see their annual premiums reduced by up to 40%!
How much better off would that example company be if they were able to keep $200,000 in their business each year instead of handing it over to an insurance carrier?
In the long term, captive owners will benefit from returns on money paid to the captive for premiums that aren’t needed to pay claims or expenses. These are typically called “underwriting profits” and the funds can be invested to increase the cash reserves of the captive or returned to the owners as dividends…or both.
Sounds too good to be true? That’s what I thought when I first learned about captives. But it’s true. Captives are great for their owners. Don’t take my word for it. Check out this study by a leading insurance advisory firm. It says captives pay less in claims than traditional insurance companies, have lower expenses, and are more profitable!
You can’t wait for the insurance industry to help you. Their interests are working against you. For suitable companies, each year that you renew your traditional insurance policies is another year you’re missing out on the benefits of a captive.
As a responsible business owner or manager you need to take control of your insurance program and resist the urge to default to “experts” who might not have your interests at heart. Here are a few tips to get you started:
Get Your Loss History
A loss run document simply details the claims that your company has incurred on the various insurance policies you hold. You may be able to get this through your broker but you can also bypass them and ask your carrier directly. Here’s a handy directory of loss run contacts for most carriers that you can reference. Try to get at least the past five years worth of data. Ten years of historicals is even better.
Consolidate Your Policy Documents
Each insurance policy that your company buys will be accompanied by a long document that summarizes the coverages, exclusions, and premiums. Almost no one reads anything in them except the first and last pages. That’s because they’re designed to confuse you. But there’s valuable information in there that you’ll need later such as your historical premiums paid. Try to consolidate documents from the same 5-10 year time period as your loss runs into a place where you can easily access & share them.
Create A List Of Your Company’s “Exposures”
Exposures is the insurance industry’s term to define information used to set premiums. Exposures include things like:
List of office, shop, work locations
List of vehicle & equipment assets
Payroll Information By Work Classification Code.
Ask Some Important Questions About Your Company
There are lots of things that you’ll need to learn about captives if you choose to pursue one but first try answering some questions about your own company, including:
Does your company spend greater than $150,000/year in combined premiums for general liability, workers’ compensation, and auto insurance?
Does your company have a relatively good claims history & financial performance?
Do you have a strong health & safety & training program in place?
Are you entrepreneurial and constantly seeking new ways to improve?
Do you take a long term view when considering business initiatives & partnerships?
If the answer to these questions is yes, you could be a good fit for a captive. That leads us to our next step.
Conduct An Initial Feasibility Study
A feasibility study has a few different elements but the initial part usually involves an actuarial analysis of your company’s loss history and premiums to determine what you would likely pay if you were to form or join a captive.
The initial feasibility study is the best way for you to determine if it’s worth pursuing a captive. It will project any immediate expected savings and it will also project your company’s expected return over time.
Existing captive service providers may charge between $4,000-$50,000 for a feasibility study.
At BuildCaptive we’re sick of the secrecy and inconvenience around captive insurance and that’s why we’re developing a free online tool that any company can use to do their initial actuarial analysis. More details below.
Tens of thousands of awesome construction companies in the US could benefit from a captive insurance program, but the insurance establishment is holding them back. Brokers aren’t properly incentivized to offer you a captive option and wouldn’t know how to get it done anyway. They also don’t want to risk the huge commissions they get from traditional policies.
Carriers are quite happy to continue providing profits to their shareholders and not their policyholders.
If you want to spend less on premiums, have more predictability year to year, and create a new long term profit center then you need to seriously consider captive insurance. The insurance industry isn’t going to help you though. You need to take matters into your own hands before you waste more money on insurance that only other people profit from.
Use our online tool to quickly find out how your company could benefit from a captive.