Article

When a business decides to form a captive insurance company, it often does so with a few main objectives—greater control over risk, improved cost management, and the ability to tailor coverage to its unique needs. But as many seasoned professionals in the insurance industry can attest, the road to a successful captive is lined with pitfalls that can undermine even the best-laid plans. Understanding these common missteps is critical for any organization considering this journey.

The Importance of Engaging Stakeholders and Legal Counsel

It often starts with a vision—a company’s leadership recognizes the potential benefits of a captive and is eager to move forward. But in their enthusiasm, some organizations make the mistake of not bringing all the right people to the table from the outset. The absence of key stakeholders—senior management, finance teams, risk managers, and, crucially, general counsel—can quickly lead to unnecessary complications that could have been addressed at the beginning. A lack of understanding from a businesses’ key stakeholders and legal team can lead to confusion that could have been addressed from the very beginning.

General counsel, in particular, plays a vital role. Insurance regulations are complex and vary widely by jurisdiction. Without legal guidance, a company might inadvertently run afoul of the law or overlook critical contract details. Similarly, failing to consult with risk managers or actuaries can result in coverage gaps or underfunded reserves. It’s not just about compliance—it’s about ensuring the captive aligns with the company’s broader strategy and risk appetite. Those who skip this step often find themselves backtracking later, at great cost and frustration.

Due Diligence: Domicile and Service Providers

Once the decision to form a captive is made, the next big question is where to put it—and who will help run it. This is where due diligence becomes paramount. Some organizations rush through domicile selection, drawn by promises of low taxes or easy regulations, only to discover later that the jurisdiction lacks regulatory stability or imposes hidden costs.

A wise company takes the time to evaluate domiciles carefully. They look at the regulatory environment, tax implications, infrastructure, and the responsiveness of local authorities. They also scrutinize potential service providers—captive managers, actuaries, auditors—ensuring these partners have both the expertise and the local knowledge to serve their needs. An inexperienced or ill-suited service provider can misprice premiums, mismanage reserves, or fail to meet regulatory requirements, putting the entire captive at risk.

Realizing You Now Own an Insurance Company

Perhaps the most underestimated aspect of forming a captive is the reality that, at the end of the day, you are now running an insurance company. This is not a passive investment or a side project—it’s a regulated business with all the attendant responsibilities.

Some companies fall into the trap of underestimating the operational demands. They may fail to diversify risks, leaving the captive exposed to catastrophic losses. Others neglect underwriting discipline, setting premiums without adequate actuarial support, which can quickly erode underwriting profit. Investment management is another area where mistakes are common; captive funds must be invested prudently to meet both regulatory requirements and liquidity needs.

Those who succeed treat the captive as a core business unit, dedicating resources and expertise to its operation. They recognize that managing risk is not just a compliance exercise, but the key to retaining underwriting profit and long-term success.

The Overlooked Necessity of Governance and Safety Protocols

Governance is the backbone of any successful captive, yet it’s often overlooked in the rush to get up and running. Without a skilled, independent board and documented policies, captives can quickly descend into operational chaos. Financial controls must be robust, with clear protocols for reserving, auditing, and investments. Hiring practices matter, too—board members and managers need captive-specific expertise to navigate the unique challenges of the industry.

Committees for underwriting, finance, and audit aren’t just bureaucratic hurdles; they’re essential for oversight and alignment with the parent company’s risk appetite. Companies that neglect these structures often find themselves facing compliance failures or strategic missteps that could have been avoided with better planning.

Other Common Pitfalls

There are other traps as well. Some companies are lured into forming captives primarily for tax benefits, only to find themselves under IRS scrutiny. Others underestimate the long-term commitment required, hoping for quick returns instead of investing in the captive’s sustained growth and stability. And inadequate capitalization—failing to fund reserves or surplus properly—can impair the captive’s ability to pay claims and meet regulatory requirements.

The Path to Success

The journey to a successful captive insurance company is not without its challenges. But by engaging all key stakeholders, conducting thorough due diligence, recognizing the operational realities of owning an insurance company, and implementing robust governance and safety protocols, organizations can avoid the most common pitfalls. In doing so, they transform their captive from a potential liability into a powerful tool for risk optimization and financial growth.

As an independent underwriting and consulting firm, Captives.Insure can assist in the coordination of all service providers and provide an objective perspective, ensuring all parties involved are privy to all aspects of the transaction, allowing key stakeholders to understand how to form and operate their captive insurance company efficiently, and effectively.