Workers Compensation Captive Insurance

Workers Compensation Insurance presents a special difficulty for captives, since they are usually not licensed to underwrite such insurance directly.

To explain why, let's back up for a second. Captive insurance companies are insurance companies that primarily underwrite the needs of the owner's other businesses. Because of this, the only one who is really at risk of failure of the captive is the owner. There are no "third persons" to look out for -- if the captive fails, only the owner will feel the hurt.

This isn't true with workers compensation. If the captive doesn't pay, it is the worker who feels the hurt of not having insurance. Thus, the insurance commissioner will usually not allow a captive to offer workers compensation insurance unless the insurance company has a bunch of capital such as $10 million or more.

This does not mean that captives cannot participate in workers compensation arrangements. They can and do, through what is known as "fronting arrangements".

In a typical workers compensation fronting arrangement, an insurance company that is licensed to offer workers compensation insurance issues the policy to the business. This insurance company, known as a "front company" or sometimes "fronting carrier", is fully responsible for claims made by workers against the policy.

Next, the owner's captive enters into a reinsurance agreement with the front company. This agreement provide that the owner's captive will take over all or a significant portion of the liability for the worker's compensation policy from the front company, in exchange for the front company giving up a part of its fee. For instance, the front company may allow the captive to take over 100% of the risk on the policy (known as "ceding" the risk"), in exchange for giving the captive 90% of the premium. The amount of premium retained by the fronting company for its troubles is known as the "fronting fee".

The front company does not want to underwrite a workers compensation policy only to discover later that the captive isn't going to pay its share of the claim. Thus, most fronting arrangements require that the captive do two things:

First, the front company will not be required to pay the reinsurance premiums to the captive until all claims for the policy period are resolved. That way the front company knows that it will at least have the amount of the premiums available to pay claims in case the captive defaults on its obligations. This is known as "premiums withheld" or sometimes "funds withheld" reinsurance.

Second, the front company will require that the captive put up either cash or an irrevocable letter of credit (LOC) to cover anticipated claims against the workers compensation policy. This way the front company knows that no matter what happens with the workers compensation policy, the front company will not suffer losses.

Once upon a time, it was difficult to convince licensed carriers to enter into fronting arrangements. Now, captive insurance companies have become so popular and fronting arrangements have become so popular that many licensed insurance companies have whole staffs that do nothing but arrange (lucrative) fronting arrangements involving workers compensation.

Of course, you could always create a captive as a fully-licensed insurance company that has the capital and has the necessary license to underwrite workers compensation insurance, but again you are looking at probably $10M+ in capital.

Since its release in late 2006, Jay Adkisson's book on captive insurance companies has become the all-time captive insurance bestseller, providing a basic introduction to captives and related structures and how they are properly utilized within the context of the client's overall business and estate planning. Available now from: Amazon and Barnes & Noble