Skip to main content

Explain Like I’m 5: Captive Insurance

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

Diving into the intricate world of insurance often feels like deciphering a complex code, especially for those not immersed in it daily. The casual use of industry jargon can leave the rest of us scratching our heads or simply giving up. As dedicated business partners, we believe in making insurance concepts accessible to everyone, inspiring a deeper understanding of their implications for organizations. Hence, the inception of our “Explain Like I’m 5” series.

Today, let’s unravel the mystery of captive insurance, with a specific focus on how a workers’ compensation captive works, exemplified by the PEC (Professional Employment Consortium) program.

For Chief Financial Officers (CFOs) overseeing a company’s financial landscape, monitoring workers’ compensation policies is part of the routine. Insurance carriers set premium rates, encompassing potential claims, overhead costs, and contributing to the carrier’s profit. CFOs often assess their company’s loss history, comparing workers’ compensation claims paid out versus the premiums paid over time. Companies prioritizing safety and risk management frequently find their claims significantly lower than the annual premiums.

In the traditional insurance realm, specific company performance isn’t a decisive factor in premium calculations, leading to a lack of recognition for years of paying fewer claims than premiums. Moreover, insurance rates generally rise annually, rarely decreasing. This dynamic places companies performing well in a position where they subsidize those who do not, particularly in industries with higher risk, like temporary staffing.

Consider two similar staffing firms, Company A and Company B. Company A has a loss ratio of 90%, paying 90 cents in workers’ compensation claims for every premium dollar. On the other hand, Company B boasts a 40% loss ratio, spending less than half its premium on claims annually. The traditional marketplace struggles to reward Company B for its exceptional performance, creating a scenario where safety-focused companies lack substantial incentives to continue their proactive approach.

So, how can an organization like Company B effectively lower its workers’ compensation costs? The solution lies in joining a workers’ compensation captive like PEC. PEC is composed of top-tier staffing organizations united by a commitment to financial strength, diligent risk management, and a proactive claims approach. These like-minded businesses collaborate to form and operate their insurance entity.

In this unique setup, the “insurance company” purchases reinsurance to mitigate potential large losses, limiting overall risk. The group captive also pre-funds premium dollars for expected losses through a loss fund, resembling traditional premium payments but with key distinctions in post-payment outcomes.

The loss fund functions as a dedicated account covering workers’ compensation claims. The objective is to “beat the bank,” meaning having fewer annual claims than the amount in the loss fund account. This allows companies to influence their annual insurance premiums based on their positive loss experience.

The benefits extend beyond cost control. Member companies often experience lower initial costs, and any surplus funds are returned as dividends, minus operating expenses. Additionally, companies enjoy the accrued investment income on their equity within the program. In essence, participating in the PEC Workers’ Compensation Program empowers companies to actively manage and control their insurance costs, reaping tangible rewards for their commitment to safety and risk reduction.

Skip to content