How to tell when a captive insurance company makes sense

How to tell when a captive insurance company makes sense

My partner, Gordon Schaller, is an expert in advising businesses on how to set up a captive insurance company, the benefits of a captive insurance company and how hotel owners can figure out if they qualify as potential candidates for captives. 

Here Gordon offers a “litmus test” for hotel owners to determine if they should investigate the opportunity to set up a captive insurance company.

Who sets up captives?

What kinds of business owners set up captive insurance companies? Starwood, Wyndham and Harrah’s (and many other hotel and gaming companies) all have captives. Marriott’s captive was used to pay for part of the cost of rebuilding its hotel in Islamabad, Pakistan, after a suicide truck bombing destroyed it in September 2008. 

Virtually all major private home builders have captives (dealing with construction defect claims and subsidence claims), as do most major owners of car dealerships and other companies that sell extended warranty insurance contracts (for example, Best Buy). Numerous firms in the construction and manufacturing businesses have also formed captive insurance companies. Finally, the vast majority of the Fortune 500 own captive insurance companies. 

But you don’t have to be that big to benefit from a captive insurance company. 

When should you think about setting up a captive?

While each business has unique factors that may impact the viability of a captive insurance company, here are three good indicators of whether a captive insurance company makes sense for a hotel owner. If you meet any one of these tests, you should look further into this opportunity.

  • If your hotel business has annual sales of at least US$75 million to US$100 million
  • If your current commercial property and casualty (P&C) premiums are at least US$500,000 annually 
  • If you suffered a recent large casualty loss (e.g., wind and weather, flood, fire, a sexual harassment lawsuit)
When deciding whether to establish a captive, the hotel owner should be prepared to pay premiums of at least US$500,000 on the new policies that will cover risks insured by the captive, as determined by independent actuaries. Since most of these risks are outside the scope of the existing commercial P&C coverage, this amount will be in addition to current premiums. Since all of the captive policies are based on “claims made” during the premium year (the ensuing 12 months), it is not required that the same coverage be continued each year. The policies can be changed or eliminated or new policies written from year to year.

Many legal, insurance and financial considerations bear on the decision to form a captive insurance company, so always obtain the advice of experienced professionals early in the process.