During the hard market phase of the property and casualty insurance market cycle — when coverage is more restrictive and expensive — many nonprofit leaders admit feeling pretty helpless. You might say that one feels “captive” by an industry that is hard to avoid.
If you rent space your landlord requires the purchase of general liability insurance. If you provide services to a vulnerable clientele, your funding source insists that you carry sexual abuse coverage. And if you’re recruiting savvy leaders to serve on the board, your new recruits are bound to ask if you have directors and officers liability coverage.
There are various ways to overcome feelings of helplessness and captivity when it comes to insuring the organization’s exposures. One increasingly viable option for nonprofits is to consider a “captive.” In the context of nonprofit organizations, the term “captive” refers to an insurance entity owned by the nonprofit and created specifically to insure the organization’s exposures.
Captives are essentially a form of self-insurance and they are set up for myriad reasons. And although most of the 5,000 captives in existence today were established by for-profits, there are many captives serving the insurance needs of nonprofits and associations. The two most common motivations for establishing a captive are to:
There are a number of myths about captives that might cause some nonprofit leaders to discount the potential value and benefits of a captive. Here are three of the most common myths.
1. Captives are pretty similar and generally only an option for large, Fortune 500 companies.
Captive structures and owners vary more than you might think. The three most common structures involving nonprofit organization owners are “pure” captives, group/association captives, and risk retention groups (RRGs). Pure captives are wholly-owned insurance entities created to insure a single organization or the organization and its affiliates or subsidiaries. This type of captive is also sometimes referred to as a single-parent captive.
Group or association captives are formed to insure the members of a group or association. Association captives are generally effective when members of a group have similar exposures and therefore similar coverage wants and needs.
Some, but not all, risk retention groups are licensed as captives. These entities are generally formed to provide liability coverage for entities with shared risk and coverage concerns.
The perception that captives are only an option for very large organizations is mostly false. It’s generally true that start-up costs, legal/regulatory complexity, and ongoing management costs put the feasibility of a pure captive out of reach for small and mid-sized nonprofits. There are other options. For example, it is possible to “rent” space in an existing captive. A nonprofit that isn’t able to fund a captive can pay a fee to rent a license and capital from a “rent-a-captive” owner.
2. There are very few options when it comes to domiciling a captive.
While the state of Vermont and offshore domiciles such as the Cayman Islands and Bermuda have become synonymous with the world of captives, any nonprofit considering the creation of a captive should at a minimum consider the lesser known domiciles. For example:
Although startup and capitalization costs might be less in an off-shore domicile, convening a captive board in an exotic, off-shore location can cause financial and image problems for a nonprofit. Travel costs for a board traveling from various cities in the U.S. to an off-shore meeting site could double or triple the cost of a similar meeting held in a U.S. domicile. Compliance with the domicile’s captive law is likely to require that all board meetings are held in the domicile or at least outside the U.S.
Second, holding board meetings in a domicile such as Barbados can create a perception problem for a nonprofit or association based in the U.S. True operating costs and the risk of reputation damage should always be factored in when considering domicile options for a nonprofit captive.
3. Captives only make sense as insurance vehicles for liability exposures.
According to the National Association of Insurance Commissioners, “practically every risk underwritten by a commercial insurer can be provided by a captive.” A recent report in Crain’s Benefits Outlook notes that Alcoa Inc., Archer Daniels Midland Co., Coca-Cola Co., Microsoft Corp. and Google have all started using captives to fund a variety of benefit plans for employees, such as accidental death and dismemberment, life insurance and long-term disability coverage. And since the passage of the Patient Protection and Affordable Care Act (PPACA), health insurance captives have been promoted as a way for mid-sized entities to gain control over the cost of health benefits for employees. A health insurance captive can be established to serve several nonprofits, operating as a group or association captive created to provide liability coverage.
There are potential, serious drawbacks to health captives along with the benefits. According to Randy Hart from CBIZ Benefits & Insurance, one of the downsides is the potential for the cost to be greater than a traditional health insurance plan due to large, required fronting fees. A potentially greater drawback of a health insurance captive is an increased exposure to risk caused by lack of diversification and the relatively small size of the insured pool or participants. Simply put, where health insurance is concerned, there is safety in numbers.
While captives are likely to remain out of reach for many nonprofits, they continue to be an option worth considering for organizations seeking to exercise control of their insurance destiny. Of course along with the reward of control comes moderate to substantial risk.
Although the appeal of the traditional, commercial marketplace is hard to resist during soft market conditions, nonprofits today have the benefit of additional options that might better suit a particular nonprofit’s risk tolerance, financial capacity and desire to control how its insures the various exposures that arise from operations. E
Melanie Lockwood Herman is executive director of the Nonprofit Risk Management Center in Leesburg, Va. She welcomes your questions, comments and feedback about the subject of this article at Melanie@nonprofitrisk.org
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