To Captive, or Not to Captive. That is the Question...Again!
How Alternative Risk Financing Can Be a Powerful for Construction Firms
CAPTIVE INSURANCE 2025: NAVIGATING AN INCREASINGLY CHALLENGING MARKET
Okay everyone, I have some news to share with you.
The commercial insurance markets are pretty tough these days, and that might be an understatement for specific lines (looking at you commercial property and auto lines). While some areas aren't horrible (e.g., workers compensation - as long as you are not in the five boroughs of New York City), some are still problematic (wildfire coverage in the Western United States).
Now for anyone who has been a regular subscriber to this newsletter, what I'm saying here isn't brand new. For everyone else relatively new to the "Greatest Risk-Focused Newsletter on Earth" (hold my beer Scott Galloway), this information may not be news to you. When we first published this article in March 2023, the Dallas Morning News had proclaimed, "Inflation stinger: Texas auto insurance rates soar 24%, homeowner's rates up 11%".
Fast forward to 2025, and the situation has only intensified, driven by several key factors that weren't as prominent two years ago.
THE RISE OF NUCLEAR VERDICTS
Perhaps the most significant development since our original publication has been the continued proliferation of "nuclear verdicts" - those jaw-dropping jury awards exceeding $10 million. What was once considered extraordinary has become increasingly common, particularly in the commercial auto and general liability spaces.
The transportation sector has been hit especially hard. We've seen verdicts routinely exceeding $20 million for seemingly routine accidents, with several high-profile cases breaking the $50 million barrier in 2024 alone. This trend has placed enormous upward pressure on commercial auto premiums, with many carriers increasing rates by 30-40% just to keep pace with loss ratios.
But the impact extends far beyond just auto coverage. The ripple effects have severely disrupted the umbrella and excess liability markets, where capacity has shrunk dramatically while prices have soared. Many businesses that could previously secure $25 million in excess coverage with relative ease now struggle to piece together $10 million, often at triple the previous cost.
For construction firms specifically, these nuclear verdicts have created a perfect storm when combined with:
DESIGN-DEFECT LITIGATION: A GROWING THREAT FOR CONSTRUCTION AND COMMERCIAL REAL ESTATE
The commercial real estate (CRE) and construction sectors have faced their own unique challenges. Design-defect litigation has exploded since 2023, with plaintiff attorneys increasingly targeting not just architects and engineers, but also general contractors and subcontractors regardless of their involvement in the design process.
Several factors have contributed to this trend:
Courts in multiple jurisdictions have expanded the definition of "design professional" to include contractors who had any input on design decisions
The economic pressure on CRE has incentivized property owners to pursue litigation as a financial strategy
Rising construction costs (and this is BEFORE those tariffs kick in!) have made remediation more expensive, driving up settlement and verdict amounts
For construction firms, the impact on professional liability and errors & omissions coverage has been severe. Many carriers have either withdrawn from the market entirely or inserted exclusions so broad that the coverage becomes nearly worthless. Those still offering meaningful coverage have increased premiums by 50-100% compared to 2023 rates.
What can I say - it's uglier out there than ever before!
Unfortunately, there is not a lot that mere mortals like you and I can do to inoculate ourselves from the economic forces behind rising retail insurance rates. Unless you own your home outright, you are required by your lender to have insurance. On top of that, if you drive a car, you MUST have insurance in the state you live in.
With respect to commercial entities, the smaller you are, the fewer options you have. However, as your firm gets bigger (and with it your premiums and your balance sheet) more options become available to you. Rather than being subject to the whims of the insurance underwriters ("We like construction firms, but only if they do commercial projects. We have no interest in residential construction."), there is a way to create your own insurance company and take more control of your risk strategies.
ENTER CAPTIVES
I'm not going to get deep here on how captives work and their different types (e.g., group captives vs. sole captives) since whole books have been written on this subject. However, I can say that captives are in essence separate legal entities that can operate as insurance companies.
In the world of construction insurance (where I'd like to think I know a thing or two), captives can come in all shapes and sizes. Specifically, there are some group captives whose members are strictly general contractors while others might have only specialty subcontractors.
Why do these structures become attractive to the owners of these firms who run their companies with solid health and safety programs and low claims activity?
It's simple. They are tired of getting treated by insurance carriers like red-headed stepchildren.
WHY DO LARGER CONSTRUCTION FIRMS USE CAPTIVES?
Now, here is a little something many people outside the construction world don't fully understand. When construction firms get bigger (say general contractors with revenues around $750M a year or more) and they use captives as part of their risk transfer program, they can become a profit center to the firm.
You read this right.
Captives can become a profit center for construction firms.
Considering how razor thin margins can be on bids, these captives can be where the larger construction firms make their real profits on jobs. Let me explain how this can work.
YOU CAN'T WIN IF YOU DON'T PLAY!
Let's say we have two self-performing general contractors bidding on a job for a commercial real estate developer. In our example it's a 10-story vertical project in a large, metropolitan center. In this scenario, Firm A uses a guaranteed cost program for its insurance. In contrast, Firm B uses a group captive with a large deductible program (say $250,000).
Now, one attraction for firms to use a captive with a large deductible program is that they can reduce their insurance premiums by retaining more of their risk. So, if we go back to our example, we know Firm A is subject to the current economic factors in the commercial insurance market. In this example, let's say that all the direct insurance costs that Firm A applies to this job (e.g., pro-rata share of its commercial insurance program for this project) come to $1,000,000. Then Firm A will apply a 3% markup to this cost and include this in their final bid for insurance costs of $1,030,000 ($1,000,000 x 1.03%).
In contrast, Firm B has a lower premium for this job (as determined by its group captive administrator) and as such all the direct insurance costs that Firm B applies to this job come to $500,000. Now, if Firm B looks at the Total Cost of Risk (TCOR) that could POTENTIALLY happen on this job (e.g., out of pocket claims cost, fees from third party adjusters (TPAs), etc.), it might look more like $900,000. Here Firm B applies a 3% markup to this cost and includes this in their bid for insurance costs of $927,000 ($900,000 x 1.03%).
It's here that the effective use of a captive can help general contractors win bids on two fronts:
All things being equal, if both firms have similar operating costs and their estimates are close to reality, then Firm B can potentially show a bid of roughly $100,000 LESS to the owner.
If Firm B can keep its claims negligible, then it could potentially see a PROFIT up to $427,000 ($927,000 less $500,000)
Now as Don Meredith, the legendary quarterback of the Dallas Cowboys once said, "If ifs and buts were berries and nuts, we'd all have a Merry Christmas!".
This saying has always stuck with me and it's particularly true with captives. A TON must go right for a captive to work to your advantage financially. You must take the health and safety of your employees and your job sites seriously. You also need to look at your risk holistically, and not just a simple function of renewing your insurance, pay your premiums, and see you next year.
CAPTIVES AS A SHIELD AGAINST NUCLEAR VERDICTS AND DESIGN LITIGATION
In today's market, with the twin threats of nuclear verdicts and increased design-defect litigation, captives offer an additional advantage: they can help insulate firms from the wild swings in the commercial market. While captives aren't immune to these trends, they do provide greater stability and predictability in pricing.
Many construction firms that entered captive arrangements prior to 2023 have found themselves in an enviable position, with premium increases that, while substantial, are still far below what their competitors are experiencing in the traditional marketplace. This pricing advantage has become even more pronounced as we move through 2025.
WARNING: CAPTIVES CAN BE DANGEROUS TO YOUR FINANCIAL HEALTH
All this being said, I have a warning for you regarding captives. As I often tell my clients, getting into a captive is like getting into the mob...
Once you get in, it's very hard to get out.
The reason is that as part of your firm taking on a large deductible within a captive, you are going to need to put up A LOT of collateral (e.g., cash, letter of credit, etc.) to help pay for those potential losses. The reason is that with a large deductible program, you are paying these claims out of your pocket until you hit the deductible threshold. Since it can take five years to get these claims resolved (hence that's why insurance underwriters ask for your current loss runs which go back five years), the captive can and will hold onto your collateral until all your claims are settled. Hence, it can take up to five years for a construction firm to get their money back once they leave a group captive. Since they often say in construction that "cash is king", this can be a big hurdle to overcome.
And in the current environment of nuclear verdicts and aggressive design liability claims, the collateral requirements have only increased. Some captives now require 150% or even 200% of expected losses as collateral, compared to the 125% that was standard just a few years ago.
Like all things, "the proof is in the pudding" or as we like to say in the world of finance "the numbers need to make sense". All this being said, there is a reason that the larger construction firms in the U.S. use some form of captives. I know from a combination of both direct professional experience as well as conversations with the senior management of many large construction firms that captives are a common solution within the industry.
It's hard to tell you when the right time is to entertain a captive, but all I can tell you is that change can come at you fast. One day you start your construction firm with just you and your truck, and the next day you have over 100 employees with projects across multiple states. One big reason for your success is because you have kept your claims and reportable incidents to a low level, hence your balance sheet hasn't taken a hit.
Fast forward to now and you want to run with the big dogs - the top 100 ENR construction firms in the country! However, you know most of them are running captives and using them as profit centers while you are still running a guaranteed cost program.
In 2025, with the commercial insurance market continuing to harden under the weight of nuclear verdicts and specialized litigation, the question isn't just "How's that going to work out?" but rather "Can you afford not to consider this option?"
Et, al…
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