Part 2: How a WC Group Captive Actually Works (Premiums → Claims → Surplus)

The Real Question: Where Does My Premium Actually Go?

In Part 1, we covered how to know if you're a fit for a group captive. Now comes the natural follow-up question: If we join, how does this thing actually work?

Most business owners have paid workers' comp premiums for years without really understanding where that money goes. You write a check to an insurance company, they handle claims, and that's about all you see. It's a black box.

A group captive flips that model inside-out. You're no longer just a policyholder—you become a co-owner of the insurance subsidiary itself. That shift changes everything about how premiums flow, how claims are paid, and what happens to the money left over at the end of the year.

Let's walk through the mechanics, step by step.

The Basic Structure: Co-Ownership of an Insurance Subsidiary

When you join a group captive, you're not simply buying a policy from a different carrier. You're becoming a part-owner of an insurance company: specifically, a subsidiary that exists to insure the risks of its member businesses.

Here's what that means in practice:

Multiple businesses (the "group") collectively own the captive. Each member has an ownership stake, typically proportional to their premium contribution or risk exposure. You're not alone in this—you're pooling resources and risk with other established, safety-focused companies.

The captive operates like any other insurance company. It collects premiums, underwrites policies, processes claims, maintains reserves, and—if necessary—purchases reinsurance to protect against catastrophic losses. The difference is that the captive exists solely to serve its member-owners, not outside policyholders.

Governance is shared. Most group captives have a board of directors drawn from the membership. You have a voice in how the captive is managed, what coverages are offered, and how surplus is allocated.

This ownership structure is what makes group captives feasible for mid-market businesses with combined P&C premiums of $125,000 to $1 million. You get the benefits of captive insurance without needing the $1 million+ premium threshold typically required for a single-parent captive.

Homogeneous vs. Heterogeneous: Two Flavors of Group Captives

Not all group captives are structured the same way. The membership composition matters, particularly when it comes to workers' compensation.

Homogeneous Group Captives (Same Industry)

In a homogeneous captive, all member businesses come from the same industry: construction companies, manufacturers, healthcare providers, etc.

Pros:

• Specialized coverage. The captive can be tailored to the unique risks of that industry. For example, a construction-focused captive understands scaffolding risks, OSHA regulations, and contractor exposures in ways a general insurer may not.
• Shared best practices. Members face similar safety challenges and can learn from each other's loss control programs.
• Industry-specific underwriting. Pricing and reserves can be structured around industry norms rather than broad market trends.

Cons:

• Concentration risk. If the entire industry experiences a hard market cycle or regulatory change, all members feel the impact simultaneously.
• Less diversification. A bad year for the industry means a bad year for the captive.

Heterogeneous Group Captives (Different Industries)

In a heterogeneous captive, member businesses come from different industries: manufacturing, distribution, professional services, hospitality, etc.

Pros:

• Risk diversification. A downturn in one industry doesn't sink the entire captive. Manufacturing losses may be offset by strong performance in professional services.
• Cycle management. Different industries experience hard and soft insurance markets at different times, smoothing volatility.
• Broader perspective. Members bring diverse risk management approaches that can benefit everyone.

Cons:

• Less specialized coverage. The captive must accommodate a wider range of exposures, which can make highly specialized terms harder to negotiate.
• Less peer benchmarking. It's harder to compare safety performance when members aren't facing the same operational risks.

Which is right for workers' comp? Both structures work. Homogeneous captives excel when an industry has unique WC exposures that benefit from tailored coverage. Heterogeneous captives excel when diversification and stability are priorities. An experienced captive consultant can help you determine which structure aligns with your risk profile.

Not sure which structure fits your business? Take our online assessment to see if a captive is right for you and get personalized guidance on the best structure for your risk profile.

The Cash Flow Cycle: Where Your Premium Goes

Now let's trace the path of your premium dollar through a group captive. This is where the mechanics get tangible.

Step 1: You Pay Premiums to the Captive

Instead of paying premiums to a commercial carrier, you pay them to the captive insurance subsidiary that you co-own. These premiums are calculated based on your actual loss history and risk profile (not industry averages).

Workers' compensation is typically one of the core lines of coverage in a P&C group captive, alongside general liability and commercial auto. Some captives also include specialized coverages like supply chain interruption, product recall expense, or cyber liability.

The key difference from traditional insurance: the premium isn't disappearing into a third-party insurer's coffers. It's going into a company you own.

Step 2: The Captive Holds Reserves

Not all claims are paid immediately. Many workers' comp claims take months or even years to settle, especially for serious injuries involving ongoing medical treatment or disability benefits.

To ensure funds are available when claims come due, the captive maintains reserves: money set aside to pay anticipated future claims. These reserves are a critical part of the captive's financial stability.

Reserves are estimated actuarially based on:

• Known open claims and their projected settlement costs
• Historical claims development patterns
• Expected future claims based on current exposures

Holding adequate reserves is non-negotiable. It's one of the reasons captives are regulated like any other insurance company: they must demonstrate financial soundness to state insurance regulators.

Step 3: The Captive Processes and Pays Claims

When a workers' comp claim occurs (a warehouse injury, a vehicle accident, a repetitive stress injury), the captive handles it just like a traditional insurer would.

Claims are reported, investigated, and paid from the captive's funds. Most captives work with third-party administrators (TPAs) who specialize in claims management, ensuring professional handling and proper documentation.

Here's where ownership creates alignment: every dollar paid on a claim is a dollar that doesn't become surplus. You have a direct financial incentive to prevent claims through better safety programs, faster return-to-work protocols, and proactive risk management.

This is why companies with captives experience 48% fewer fatalities and 22% fewer workers' compensation claims compared to traditionally insured businesses. The incentive structure changes behavior.

Step 4: The Captive May Purchase Reinsurance

What happens if your captive faces multiple large claims in a single year (perhaps several serious workplace injuries or a catastrophic auto accident)?

To protect against this scenario, many captives purchase reinsurance: essentially, insurance for the insurance company. Reinsurance kicks in when claims exceed a certain threshold, protecting the captive's reserves and ensuring members aren't hit with unexpected assessments.

Think of reinsurance as an umbrella policy for the captive itself. It's an additional cost, but it provides critical financial protection and stability.

Step 5: Unpaid Premium Becomes Profit (Surplus)

Here's the payoff: at the end of the year, any premiums that weren't paid out on claims, held in reserves, or spent on reinsurance and operating expenses become profit for the captive (also called surplus or underwriting gain).

Because you're a co-owner of the captive, that surplus belongs to you and your fellow members.

What happens to it?

• Retained in the captive to strengthen reserves and provide a financial cushion for future years
• Distributed back to members as dividends or profit-sharing payments (typically after a few years once reserves are stabilized)
• Used to fund loss control initiatives like safety training, equipment upgrades, or wellness programs

This is the fundamental difference between traditional insurance and a captive. In traditional insurance, underwriting profit goes to the carrier's shareholders. In a captive, it stays with the member-owners—the businesses that paid the premiums in the first place.

Where Surplus Comes From (And Why Safety Drives It)

Surplus doesn't happen by accident. It's the direct result of paying fewer and smaller claims than your premiums anticipated.

Think of it this way:

Premiums are calculated to cover:

1. Expected claims (based on your loss history)
2. Reserves for future claim development
3. Reinsurance costs
4. Administrative expenses (TPA fees, actuarial costs, regulatory fees)
5. A margin for unexpected volatility

If your actual claims come in lower than expected (because you invested in safety, improved training, implemented return-to-work programs, or simply had a good year), the difference flows to surplus.

Safety isn't just a moral imperative; it's a profit driver.

This is why captive membership creates such powerful alignment. Every prevented injury, every avoided accident, every claim closed early contributes directly to your bottom line. The more proactive you are about risk management, the more surplus you generate.

And because surplus can eventually be distributed back to members, you're literally profiting from your own safety culture.

A Simple Example: Following One Year of Premiums

Let's make this concrete with a hypothetical member company:

ABC Manufacturing

• Combined P&C premiums: $250,000 (WC: $150,000 | GL: $60,000 | Auto: $40,000)
• Loss ratio target: 50%

Year 1 Cash Flow:

• Premiums paid to captive: $250,000
• Claims paid: $100,000 (better than expected: strong safety year)
• Reserves set aside: $25,000 (for claims not yet settled)
• Reinsurance cost: $20,000
• Admin/operating expenses: $15,000
• Remaining (surplus): $90,000

That $90,000 doesn't disappear. It's retained in the captive, strengthening its financial position. After 3–5 years of consistent performance, ABC Manufacturing may receive profit distributions based on their proportional share of cumulative surplus.

Meanwhile, in a traditional insurance scenario, that $90,000 would have gone to the carrier's bottom line, and ABC would never see it again.

Why This Structure Works for Workers' Comp

Workers' compensation is an ideal line of coverage for group captives because:

1. Predictable frequency. Most businesses have enough historical WC data to actuarially model expected claims with reasonable accuracy.
2. Manageable severity. While some WC claims can be large, catastrophic claims are relatively rare—and that's what reinsurance is for.
3. Safety is controllable. Unlike some risks (like natural disasters), workplace injuries are largely within a business's control. Better safety programs directly reduce WC claims.
4. Long-tail claims favor ownership. WC claims often take years to settle. In a traditional policy, you're paying reserves to the carrier but never seeing that money again if claims settle for less. In a captive, those reserve releases become surplus.

The Transparency Advantage

One final point: in a group captive, you see everything.

• How much was paid on each claim
• How reserves are calculated and adjusted
• What administrative costs are running
• How reinsurance is structured
• Where surplus is being allocated

This level of transparency doesn't exist in traditional insurance. You get an annual policy statement and that's about it.

In a captive, you're an owner. You have access to detailed financials, actuarial reports, and claims data. You understand exactly where every premium dollar is going—and you have a say in how the captive operates.

For business owners who value control and accountability, this transparency is often as valuable as the cost savings.

Ready to See How the Numbers Work for Your Business?

Understanding the mechanics is one thing. Seeing how it would actually play out with your premiums, your loss history, and your risk profile is another.

That's where a feasibility analysis comes in.

If you've confirmed you're a fit (Part 1) and now understand how the cash flow works, the next step is to model what captive participation would look like for your specific situation over a 5- to 10-year horizon.

Want to see the numbers? Schedule a 15-minute walkthrough where we'll map the premium → claims → surplus flow using your actual data. Schedule your captive feasibility call

Or, if you haven't taken the preliminary assessment yet: Start the online assessment

Want to dive deeper into the structure and benefits first? Download the complete guide: Putting a Property and Casualty Group Captive to Work for Your Business.