Viewpoint: Captive market broadens

Small and midsize businesses, just like their larger counterparts, are not immune to volatile commercial insurance markets, and as they continue to navigate various economic headwinds including inflation it’s encouraging to see a growing number dip their toes in the captive insurance sector.

Capitalization requirements, high operating costs and fear of regulatory scrutiny may have discouraged smaller companies from establishing captive insurers in the past, but that is changing. Indeed, as we report on page 10, businesses of all sizes continue to consider captives as they look for alternative capacity and greater control over their risk financing costs in lines like property. Captive market growth doesn’t yet appear to have slowed down, even as conditions in some lines of insurance are improving. Buyers continue to explore all and every possible risk financing option, based on recent broker surveys.

A greater variety of captive structures is available, which in turn has accelerated captive growth among small and midsize businesses. Group captives have long helped lower the barriers to entry for midsize businesses and make the captive formation process more affordable. While single-parent captives traditionally have been financially feasible only for large, well-capitalized companies, group arrangements offer midsize companies in the same industry or across different industries an efficient alternative mechanism to manage their risks and control their insurance costs.

Meanwhile, several captive domiciles have enacted legislation allowing cell captives, which is spurring more growth. Vermont has 64 sponsored captives which house captive cells, and more than 500 cells and separate accounts within those entities, for example. Not all of these are formed by small businesses, but many companies may test out the idea of a captive through a cell. Of the 659 licensed captive insurance companies domiciled in Vermont as of year-end 2023, 378 wrote gross written premium of $10 million or less and 306 of those wrote $5 million or less in gross written premium, according to a recent report by the Vermont Department of Financial Regulation.

Meanwhile, technology is leading to greater creativity and making the captive formation process more efficient. As we report on page 37, in the case of Marsh’s ReadyCell facility, one of Business Insurance’s U.S. Innovation Awards winners, artificial intelligence technology is powering a platform designed to allow organizations to form captives within minutes, cutting cell formation times and lowering costs even further. Any line of coverage and any amount can be placed within a ReadyCell, though typically it would insure a single line of coverage or a layer within a larger insurance program, to ensure costs remain low.

As captive structures expand and technology continues to advance, more innovative adaptations of captive vehicles will be developed, and small and midsize businesses are likely to benefit from a leveler playing field. But just because access becomes easier and more affordable shouldn’t mean that the pros and cons aren’t properly weighed. Prospective captive owners must evaluate the full range of options available — whether rent-a-captives, series, protected or incorporated cells, or group captives — to figure out what is the best fit for their individual company. And smaller companies, in particular those looking to benefit from 831(b) tax elections — under which the U.S. government taxes them only on investment income if their annual premiums are less than $2.8 million — would be wise to take a cautious approach, given the IRS’s skepticism over the validity of many 831(b) captives.