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Explain Like I’m 5: Captive Insurance

By February 6, 2024February 7th, 2024No Comments

In the world of insurance, the language used can often sound like a foreign code to those not immersed in it daily. The constant use of jargon can be bewildering for the average person, leaving many feeling lost and unsure. Recognizing the need for clarity and understanding, we initiated our “Explain Like I’m 5” series, aiming to simplify complex insurance concepts for everyone to comprehend and apply to their specific situations.

Today, our focus is on demystifying captive insurance, particularly how it operates in the realm of workers’ compensation, exemplified by the PBA Workers’ Compensation Program.

For business owners responsible for their company’s financial health, monitoring workers’ compensation policies is a common practice. In the traditional insurance landscape, premium rates are determined by carriers, covering potential claims, overhead costs, and contributing to the carrier’s profit margin. However, the system lacks a direct link between a company’s performance and its premium rates.

Typically, insurance rates tend to increase yearly, offering little reward for companies that excel in safety and risk management. This is especially relevant in high-risk industries like construction. Imagine two similar homebuilders, Company A and Company B. Company A has a higher loss ratio, paying out 90 cents for every premium dollar in workers’ compensation claims, while Company B, with a lower loss ratio of 40%, spends less than half its premium on claims.

In the traditional marketplace, there’s no mechanism to adequately reward Company B for its outstanding performance. This is where a workers’ compensation captive, such as the PBA Workers’ Compensation Program, comes into play.

Companies like Company B can join a workers’ compensation captive where like-minded businesses collaboratively form and run their insurance entity. This captive purchases reinsurance to mitigate large losses and establishes a loss fund to pre-fund expected losses, similar to traditional premium payments but with crucial distinctions.

The loss fund functions like a dedicated account for handling workers’ compensation claims. The goal is for companies to have fewer annual claims than the amount in their loss fund, allowing them to directly influence their annual insurance premiums based on their positive loss experience.

But the benefits extend beyond just cost control. Member companies often experience lower initial costs, and any surplus funds are returned as dividends, minus operating costs. Furthermore, companies enjoy the accrued investment income on their equity within the program. In essence, participating in a workers’ compensation captive empowers companies to actively manage and control their insurance costs, providing tangible rewards for their commitment to safety and risk reduction.

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