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Explain Like I’m 5: Captive Insurance

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

In the world of insurance, the language used can often sound like a foreign code to those not immersed in it daily. The constant use of jargon can be bewildering for the average person, leaving many feeling lost and unsure. Recognizing the need for clarity and understanding, we initiated our “Explain Like I’m 5” series, aiming to simplify complex insurance concepts for everyone to comprehend and apply to their specific situations.

Today, let’s unravel the intricacies of captive insurance, with a specific focus on how a workers’ compensation captive works, exemplified by Hearten.

Executive Directors, tasked with overseeing their organization’s financials, routinely monitor the company’s workers’ compensation policies. In the traditional insurance landscape, carriers determine a premium rate, covering potential claims, overhead costs, and contributing to the carrier’s profit. Executive Directors often analyze their organization’s loss history, comparing workers’ compensation claims paid out versus the premiums paid overtime. Organizations prioritizing safety and risk management frequently find their claims significantly lower than the annual premiums.

In the traditional insurance market, specific organizational performance is not the primary factor considered when charging premiums. Consequently, there is no tangible reward or incentive for organizations that consistently pay out fewer claims than they did in premiums over the years. Compounding the challenge, insurance rates generally increase annually, seldom decreasing. This dynamic means that well-performing organizations often end up subsidizing those that do not, especially in industries with higher risk, such as human and social services.

Consider two similar organizations, Organization A and Organization B, offering identical services. Organization A has a loss ratio of 90% per year, paying 90 cents in workers’ compensation claims for every premium dollar. In contrast, Organization B maintains a 40% loss ratio, spending less than half of its premium on workers’ compensation claims each year. The traditional marketplace struggles to adequately reward Organization B for its exceptional performance. Despite their focus on safety and minimizing claims, there is no substantial incentive to continue these efforts.

So, how can organizations operating similarly to Organization B effectively lower their workers’ compensation costs? The solution lies in joining a workers’ compensation captive like Hearten. Hearten is comprised of best-in-class human and social services organizations sharing a commitment to financial strength, diligent risk management, and a proactive approach to claims management. These like-minded organizations collaborate to form and operate their insurance entity.

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

The loss fund operates as a dedicated account for managing 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 organizations to influence their annual insurance premiums based on their positive loss experience.

The benefits extend beyond cost control. Member organizations often experience lower initial costs, and any surplus funds are returned as dividends, minus operating expenses. Additionally, organizations enjoy the accrued investment income on their equity within the program. This can be a game-changer for nonprofit organizations with budget restrictions, providing a sustainable and financially savvy approach to managing workers’ compensation costs.

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