The Downsides of Captive Insurance: What Businesses Should Know
Captive insurance has become an increasingly popular risk management tool for businesses seeking more control over their insurance programs. While there are clear advantages to setting up a captive—such as customized coverage, potential cost savings, and improved risk management—it’s not a perfect solution for every organization.
At Eugene C. Yates Insurance Agency, we believe in transparency and helping clients understand both the benefits and the limitations of their insurance choices. In this post, we explore the potential downsides of captive insurance to help you make an informed decision.
1. High Initial and Ongoing Costs
Starting a captive insurance company isn’t cheap. It involves substantial upfront investment for legal formation, actuarial evaluations, licensing, and regulatory approvals. On top of that, you’ll need to meet minimum capital and surplus requirements, which vary depending on the jurisdiction.
Even after formation, the costs don’t stop. Ongoing administrative, regulatory, and compliance expenses can add up quickly. For small to mid-sized businesses, these expenses can outweigh the potential financial benefits.
2. Complex Regulatory Landscape
Captive insurance is heavily regulated, and requirements vary by domicile (the state or country where the captive is licensed). Complying with these laws demands expertise and time. Captives must file annual reports, undergo audits, and remain compliant with changing rules and tax codes.
For businesses without dedicated legal or insurance teams, managing this compliance burden can become overwhelming.
3. Significant Management and Operational Demands
Captives are not “set-it-and-forget-it” solutions. They require ongoing management, including underwriting, claims processing, investment oversight, and regulatory reporting. This typically requires a team of professionals or third-party captive managers, which can significantly increase operating costs.
If not managed effectively, the captive may fail to deliver its intended value.
4. Risk Concentration and Financial Exposure
Captives insure the risks of their parent companies or affiliated entities. This can lead to a concentration of risk, particularly if the business operates in a single industry or geographic area.
In the event of a major loss, the captive may struggle to meet its obligations, potentially requiring additional capital from the parent company.
5. Potential IRS Scrutiny and Tax Risks
While captives can offer tax advantages—such as deductions for premiums—improperly structured captives may attract unwanted attention from the IRS. If the IRS deems that the captive lacks true risk transfer or exists primarily for tax avoidance, the deductions may be disallowed and penalties imposed.
It’s critical to ensure the captive meets the IRS’s definition of a legitimate insurance arrangement.
6. Limited Coverage for Catastrophic Risks
Most captives are designed to handle predictable, manageable risks. They are typically not structured to absorb high-severity, low-frequency events—like natural disasters—without external reinsurance. This can result in gaps in coverage or additional costs for reinsurance contracts.
7. Liquidity and Investment Constraints
Since captives must maintain reserves to cover potential claims, those funds aren’t readily accessible for other business needs. This can create liquidity challenges, particularly during periods of financial strain or unexpected losses.
Final Thoughts: Is Captive Insurance Right for You?
Captive insurance can be a powerful tool—but only when implemented with careful planning, sufficient resources, and clear long-term objectives. At Eugene C. Yates Insurance Agency, we recommend captive structures for businesses that:
- Have predictable loss patterns
- Are financially strong
- Can afford the initial and ongoing costs
- Understand the regulatory and operational requirements
For many companies, traditional commercial insurance or a hybrid approach may provide more flexibility and fewer administrative burdens.
If you’re exploring alternatives to traditional insurance and considering a captive, speak to one of our experienced agents. We’ll help you weigh the pros and cons and determine the best strategy tailored to your business goals.
Need expert guidance?
Contact Eugene C. Yates Insurance Agency today for a custom insurance consultation.