Higher Premium

August 05, 2014

WTbutton2012

To answer your question, first I should say that premiums must be set in an arm's length manner and must be appropriate or reasonable for the risk insured, otherwise the transaction may not be deemed to be insurance. For example, if you pay a premium of $1Million for $1Million of coverage, this would not be insurance and would have to be accounted for as a deposit.

Now, that said, someone may choose to pay more conservative premiums, while still appropriate premiums, which may make it more likely that the captive will earn underwriting profits.

I cannot see any major benefits of doing so in most cases, but some benefits that could potentially arise could be the following:

  • A way to build surplus in the captive more rapidly so that the captive could be in a position to take on more risk down the road especially if there is an expectation that the market may be hardening. If this does not occur, the excess surplus could then be returned via a dividend, but if needed, the captive is ready to go. Building surplus faster could be a benefit too if the captive owner is interested in having its captive rated by AM Best down the road, for example.

  • In some circumstances, the captive may be able to invest its funds more freely than the parent, so excess funds in the captive may allow the parent to earn more in investment income in the captive. This is not common, but it is a possibility.

  • There might be some accounting benefits. Keeping the insurance budgets at the insurance subsidiaries at a higher level so that there is no issue with raising such premiums in harder markets while not having consolidated effects on the whole organization.

  • There might possibly be some tax benefits if the premiums are deductible, but this is a complex topic.

There could be a few other small or less common benefits, but these are the main ones that come to mind. The regulators, of course, like folks to be conservative when setting premiums as it makes the captive more financially solid and at the end you are sort of paying the premiums to yourself (assuming a wholly owned single captive arrangement).