Captive insurance

Captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well. Using a captive insurer is a risk management technique by which a business forms its own insurance company subsidiary to finance its retained losses in a formal structure.

Origin of term

The term "captive" comes from the "father of captive insurance", Frederic M Reiss, who coined the term while he was bringing his concept into practice for an industrial client in Ohio in the 1950s. The term "captive" came to Reiss when working with his first client, the Youngstown Sheet & Tube Company. The company had a series of mining operations and its management referred to the mines whose output was put solely to the corporation's use as captive mines. When Reiss helped the company incorporate its own insurance subsidiaries, they were referred to as captive insurance companies because they wrote insurance exclusively for the captive mines. Reiss continued to use the term for his concept, and both the captive and the term have adopted a far wider context. The term also made sense as the policyholder owns the insurance company i.e. the insurer is captive to the policyholder. If the captive insures only its parent and affiliates it is called a pure captive.

Domicile

Captives are licensed by many jurisdictions with the primary jurisdiction known as the captive's domicile. Many captive insurers make their home "offshore." Belize, Bermuda, The Cayman Islands, Ireland, Guernsey, Luxembourg, Barbados, Malta, Singapore, Anguilla, the British Virgin Islands, Qatar Financial Centre and Dubai International Financial Centre are a few examples.

Bermuda was once a leading offshore captive domicile, and its market dominance has long since decreased as many jurisdictions enacted captive-friendly legislation to attract or preserve this type of business. The onshore regulatory burden and cost of operating either a US-based or Lloyd's-based captive in the early 1960s drove Reiss to seek out a jurisdiction that would allow his captive concept to flourish. After significant travel and investigation, Bermuda was Reiss' first choice for its geographic location, clean reputation and its position as a British Dependent Territory, which removed the risks and uncertainties often experienced by international businesses operating in politically unstable and unaccountable jurisdictions. Bermuda's captives are predominantly owned by large US corporations. Thus, for instance, American International Group (AIG) operated a captive insurance scam that involved fraudulent use of Bermuda as an offshore tax haven. The Cayman Islands is the second largest licensing jurisdiction in terms of the number of captives licensed. Vermont is second in terms of insurance company assets but third in terms of captives licensed.

In the United States, Vermont is home to more captive insurers than any other US state, with nearly 900 licensed captive companies as of August 2009.^{[citation needed]}

Policies

Reiss conceptualized the captive to provide his clients with coverages they needed but could not obtain through the traditional insurance market, thereby reducing the high cost of insurance to large corporations. The most common use of captive insurance is to provide liability coverages for those lines of business, such as workers' compensation, that have regular and predictable loss payments and for working layer professional liability coverage in order to access the reinsurance market, including Lloyd's syndicates, for excess protection that may be unavailable or cost-prohibitive at the primary level such as products liability, general and professional liability and directors and officers liability. Vehicle insurance, both property damage and third party liability of corporate fleets and vehicles is also quite common.

Regulation

For some lines of business a captive can operate without restriction. In other cases, such as workers' compensation in the U.S., for example, a captive often must go through a fronting process. They pay a fee, usually somewhere between 5 and 15 percent, to participate in the risk. The fronting insurer issues the required policy using its insurance licenses and then the company "cedes" (sends some or all the risk and some of the premium) to the captive. If there is a loss, the captive provides the funding to pay the loss even though the contractually responsible party from the injured party’s perspective is the commercial "front". Because premiums paid to captives are deductible, the terms of the policy (including the premium amount) must be reasonable. A captive cannot arbitrarily set the premium amount simply to generate a deduction for the parent. For example: Smith Dentists Inc. is insured by the company's captive, Acme Insurance, for loss of employee wages, fire, loss of computer equipment, etc. Acme Insurance cannot arbitrarily set the policy premium at $50,000, but, rather, should base the premium amount on actuarial projections.

In the European Union, a new set of regulatory requirements (Solvency II) is planned with additional tasks and responsibilities for captives and reinsurance companies. Some European captives ask for simplified regulation.

Captive Manager

Reiss created the first captive management company, International Risk Management Limited (IRML), in Bermuda in 1962 to provide the administration of his client's captives. Most captive management is usually outsourced to a captive manager located in the jurisdiction that holds the primary license for the captive. The two largest captive insurance company managers in the world are units of Marsh & McLennan Companies and Aon Corporation -- the two largest commercial insurance company brokerages in the world. Each manages more than 1,000 captive insurers.

Main captive domiciles

Domicile	Captive Number	Percentage
Bermuda*	958	19.3%
Cayman Islands*	765	15.4%
Vermont*	567	11.4%
Guernsey*	368	7.4%
Luxembourg*	262	5.3%
Barbados*	256	5.2%
Ireland*	224	4.5%
British Virgin Islands*	195	3.2%
Hawaii*	163	3.3%
South Carolina*	158	3.2%
Isle of Man	130	2.6%
Nevada*	115	2.3%
Arizona*	108	2.2%
Utah	100	2.0%
Turks & Caicos	71	1.4%
Singapore	57	1.1%
Sweden	41	0.8%
Switzerland	41	0.8%
District of Columbia	40	0.8%
Labuan#	32	0.6%
New York	27	0.5%
Netherlands	26	0.5%
Vanuatu	25	0.5%
Bahamas	23	0.5%
Total	4,966	100.0%

Not listed above by Business Insurance News is Anguilla which has more than 200 captives as of August 2009.

*2008 Updated stats. Source: Business Insurance News Captives 2008
**2008 Updated stats. Source: http://www.captive.utah.gov/hotnews.html
#2007 Updated stats. Source: LOFSA 2007 Annual Report

See also

• Reinsurance
• Catastrophe bond
• Reinsurance sidecar

Further Reading

• Sierk, R. Wesley, Taken Captive: How to Capture Your Piece of America's Multi-Billion Dollar Insurance Industry RMA PRESS, 2008 www.takencaptive.com. ISBN 978-0-9801925-0-6

• Adkisson, Jay D., Adkisson's Captive Insurance Companies: An Introduction to Captives, Closely Held Insurance Companies, and Risk Retention Groups. iUniverse, Inc., 2006. ISBN 0595422373; ISBN 978-0595422371.

• Duffy, Catherine R. Held Captive. A History of International Insurance in Bermuda. Toronto, ON. Oakwell Boulton, 2004. ISBN 0-920831-99-0

• Captive Review provides a global trade publication, website, training seminars, conferences and data products

External links

• Book: Taken Captive by R. Wesley Sierk, IIII [2]