By Devin O'Brien and Ryan Ring
Putting one's own capital at risk is a fundamental pillar of a captive insurance company. While the assumption of risk requires proper management of a company's liabilities, it's often overlooked that the asset side of the balance sheet is of equal or greater importance. The scale of capital required upon the inception of a captive, and the uncertainty around the timing and magnitude of future claims, are as critical to the success of a captive as those related to a captive owner's risk assumption appetite. Consequently, the management of this capital and the corresponding investment decisions is a key function within a captive's operation, as well as being a primary driver of the long-term viability and, ultimately, the profitability of the program.
Understanding the traditional commercial insurer's business model sets the stage for a deeper appreciation of the unique benefits and considerations of a captive's asset management strategy.
Simply stated, insurance companies make money through two primary sources:
- Underwriting Income: earned premium remaining after losses and administrative costs
- Investment Income: earnings from an increase in the value of investments (interest, dividends, capital appreciation)
While traditional markets must first rely on experienced underwriters and actuaries for the selection and pricing of insured risks, it's how the resulting premium dollars are invested that ensures adequate reserves and cash flow to meet current and future claims payments. In addition, investment returns generated on unused premiums can deliver a substantial source of profit and shareholder returns.
Learn more in our whitepaper, Delivering Successful Captive Outcomes: The Importance of the Investment Management Process.
