AS A HOME BUILDER, DO YOU FEEL LIKE PERSONA NON GRATA WITH insurance companies these days? You're not imagining things. According to insurance experts such as Jenny Schaefer, with Hilb, Rogal and Hobbs, (HRH), an insurance brokerage firm with offices all over the United States, few insurers want to touch a builder with an 8-foot 2x4 these days.

“I think of the 30 major carriers we represent, only three will provide home builders with general liability and workers' compensation,” Schaefer says. “They've just had too many problems. First, it was asbestos, then construction defects and mold. There's always some new unknown out there.”

If you poke around online, you'll find a few companies that advertise builders' insurance. But with most plans, fewer risks are covered than in past years, with a large share of any financial damages falling on the builder's shoulders.

That pattern, says Schaefer, is here to stay. But there is one way builders can temper that bad situation: by enrolling in a “captive” plan. Under this sort of plan, you accept a much larger financial share of any future liability—and pay it in advance. A captive plan often costs much more than conventional insurance used to (when you could get it), but along with the pain come a few perks, including greater control over claims and the potential for profit if the money you have squirreled away is not needed. A captive fund also may be the only way you can secure the additional conventional insurance you need to cover your risk of big losses.

“Builders need to understand that over time they'll be paying their own claims anyway,” Schaefer explains, “whether that payment is in higher premiums or from a fund they set aside, as in the case of a captive. The difference is, with a captive, they have control over the claims process and who, if anyone, gets paid from that fund.”

Here's a short primer on the ins and outs of captive insurance—what it is, who provides it, and how it works. If you like the sound of this sort of coverage, be sure to follow our online links to get more information on the topic or to locate a program in your area.

1. Why Go Captive?

Here are a few good reasons to join a captive insurance plan:

  • Desperation. Your old insurance has been canceled, and you can't find a new conventional insurer you can afford. The cause might be simple bad luck or a past claim that has made you an insurer's nightmare.
  • Frustration. You're tired of suffering the indignity of volatile insurance premiums.
  • Emancipation. You have enough confidence in your safety record and product to bet on your own company and set aside money that you can control and invest in your own way.
  • 2. Option A: Start From Scratch

    Creating a captive is much like forming a new business, whether you are a larger builder and want to take that leap or as a small builder interested in banding together with other smaller builders. You also could get a cold shoulder from some existing captives, many of which have strict rules for new members. Here are the bones of the creation process:

  • Research. Conduct a feasibility study that looks at participants' history and projected costs based on risk assessment.
  • Plan. Create a business plan for the captive that includes estimates for the amount of money that will need to be set aside each pay period to capitalize the risk fund. This plan will also look at what to do with that fund while it's idle (i.e., where will it be invested?).
  • License. Obtain the necessary licensure.
  • Pay Up. Capitalize the captive (create the initial nest egg of capital).
  • Go. Begin operations.
  • 3. Option B: Join An Existing Plan

    Setting up a captive is complex and fraught with financial and administrative challenges. You may be better off joining an existing captive plan or hiring a third party to set up and run yours. Here are a few reasons why:

  • Money. You need a large chunk of change initially to capitalize the plan. There will also be legal and other filing fees for preliminary set up. (Have you got $100,000 sitting around in an account somewhere?)
  • Regulations. When the rules change, you need to know about them, so you'll need legal advice on a regular basis.
  • Staff. The fund will need to be managed regularly. Creating a captive requires about a half dozen intermediaries, from auditors to claims administrators. These service providers come prepackaged when you buy into an existing plan.
  • 4. Benefits Of Control

    Several types of captive plans exist, allowing you different levels of control over your capital. In the best-case scenario, you will gain:

  • Purchasing Clout. Along with the capital fund that underlies your plan, you will likely need catastrophic insurance (conventional). Your captive group will be able to get more protection at a reduced cost.
  • Estate Planning. Capital that goes unused in your plan may be passed down as part of your family-owned business assets.
  • Investment Choices. Because the capital fund is yours, you invest it as you choose.
  • Profit Center. Money gained from investing the capital can be used to lower your future payments or put back into your business in other ways.
  • 5. Caveats: Before You Buy

    Be aware of a few “gotchas” before you buy in to a captive insurance plan:

  • Workers' Compensation Coverage. Rules regarding the use of captive plans vary from state to state. At least two states—West Virginia and Ohio—do not accept captive plans for workers' comp coverage.
  • Higher Cost. Captive plans are typically much more expensive than conventional plans (if you can find one), primarily on the front end.
  • Exclusivity. Joining a captive may be tougher than just knocking on the door of your local HBA. Many captive plans now have strict rules about membership and ask for extensive records of your company's past performance. Be ready to come clean.
  • The Costs In this sample, a captive group fund requires an annual premium pay-in of $6 million. But the actual cost to members of the captive ends up significantly lower (68.5%) because money in the capital fund can be invested and reinvested to lower future premiums or as a hedge against unexpected losses.


    Premium pay-in $6,000,000 100%
    Fixed expenses ($2,400,000) 40%
    Loss fund for claims $3,600,000 60%
    Actual claims paid ($1,800,000) 30%
    Underwriting profits $1,800,000 30%
    Investment income (II) $481,000 8%
    Total profits and II $2,281,000 38%
    Premiums: $6,000,000 100%
    Less profits & II ($2,281,000) 32%
    Ultimate cost of insurance $3,719,000 68%

    BAD BETS Insurance companies have lost billions in recent years due to unexpected claims and expenses.

    The last few years have not been kind to property and casualty (P&C) insurers. Claims have consistently exceeded annual premiums. Many firms have reserves with which they make up these deficits—but some have gone under. The survivors have restructured, raised premiums, and tightened policies to try to check losses. Where home builders are concerned, they point to class-action lawsuits over mold and asbestos contamination. In addition, workers' compensation claims continue to pummel insurers. For example, a Syracuse, N.Y., carpenter recently walked away with $1,100,000 after he fell 20 feet on a jobsite and fractured his wrist. Other big payouts to homeowners followed hurricanes, winter storms, and flooding. And the 2003 claims for wildfire losses may beat all previous records.