Captive insurance
Captive insurance companies are limited purpose insurance companies established with the specific objective of financing risks emanating from their parent group or groups, they sometimes also insure risks of the parent company's customers. A captive is a risk management technique where a large corporation can finance losses by making payments to a wholly owned subsidiary called a captive insurer who then pays the losses. If the captive only insures its single parent corporation and/or subsidiaries owned by the parent it is called a pure captive. Captives are located in many places offshore from the United States, including Bermuda, Cayman Islands, Vermont, Guernsey, Luxembourg, Barbados, and the British Virgin Islands. These locations have few regulatory restrictions and can offer more favorable tax treatment compared to domestic captive insurance companies. Captive insurance companies initially used captives as tax-reduction vehicles but over the years many companies have turned to captives because some of their insurance premiums have risen significantly. More and more companies are establishing captives to insure a variety of risks, including property and casualty, general and auto liability, product liability, and employee benefits such as long-term care and supplemental life insurance plans. Loss finance through captives is essentially self-insurance or retention. Mainly captives can be used to reduce risk. Offshore captive insurers have lower tax rates on investment and underwriting income which reduces expected tax payments relative to domestic captives. Captives allow businesses to purchase excess insurance coverage directly from reinsurers since reinsurers have less stringent regulation. Captives also allow firms to retain a large portion of its risk and still satisfy insurance requirements, regulations, and demands from third party certificates. If a firm wants a captive and wants to insure the company through a captive they must go through a fronting process and pay a fee of usually somewhere between 5 and 7 percent. The fronting insurer then makes a policy and then the company cedes the insurance premium and any loss to the captive. If there is any loss, the captive pays the losses. This is all in an effort to be self insured, which is what a captive is.
The administration of a captive is usually outsourced to a specialised captive manager, who is often located in an offshore jurisdiction.
The most common use of captive insurance is to cover medical malpractice, due to the high cost of such coverage by traditional insurers. Vehicle insurance, chiefly for physical damage and passenger liability, is also quite common.[1]
Types of Captive
There are several types of insurance captives, the most common are defined below:
- Single Parent Captive - is an insurance or reinsurance company formed primarily to insure the risks of its non-insurance parent or affiliates.
- Association Captive - is a company owned by a trade, industry or service group for the benefit of its members.
- Group Captive - is a company, jointly owned by a number of companies, created to provide a vehicle to meet a common insurance need.
- Agency Captive - is a company owned by an insurance agency or brokerage firm so they may reinsure a portion of their clients risks through that company.
- Rent-a-Captive - is a company that provides 'captive' facilities to others for a fee, while protecting itself from losses under individual programs, which are also isolated from losses under other programs within the same company. This facility is often used for programs that are too small to justify establishing their own captive.
Two other types of insurance companies which have developed recently are special purpose vehicles (SPV) and segregated portfolio companies (SPC):
- SPV - Although used extensively in the past for various financing arrangements, recently they have been used for catastrophe bonds and reinsurance sidecars.
- SPC - SPCs can be formed as a rent-a-captive facility to enable those companies who lack sufficient insurance premium volume, or who are averse to establishing their own insurance subsidiary, access to many of the benefits associated with an offshore captive.
Commercial Advantages and Issues
The key issues with captive insurers is that they are conduits for risk -- unless risk is placed with the captive it remains with the owner. There are a number of commercial advantages to using captives to provide a better risk management than the conventional insurance market.
- Cost. Premiums charged by commercial insurers include amounts to cover the insurer's profit margin and overheads. Such overheads can be significant when considering insurers with large corporate structures to maintain.
- Flexibility. When the market is soft, the captive can take advantage of the low rates by reinsuring a relatively large proportion of its risks. The low cost of reinsurance allows the captive to build its reserve base. When the market hardens, the captive is able to retain a larger proportion of its risks, and can maintain cover for its parent even when commercial insurance is unavailable or prohibitively expensive.
- Claims management. The process of making a claim from a third party insurer can be long and involve a good deal of cost for the claimant. Where the insurer is a captive, the claims handling procedures can be dictated by management, cutting down on the delays and bureaucracy that are often a necessary part of the claims handling procedures of commercial insurers.
- Claims experience benefits. Captives generally retain a portion of the overall risk and reinsure the remainder. For this reason, when claims experience is better than anticipated, the excess of net premiums over claims is retained by the group. The reinsurance taken out by the captive is tailored to minimise the group's exposure where claims experience is worse than projected.
The types of risk that a captive can underwrite for the parent include property damage, public and products liability, professional indemnity, employee benefits, employers liability, motor and medical aid expenses.
Captives are becoming an increasingly important component of the risk management and risk financing strategy of their parent. A number of reasons have been put forward as the basis for the growth in the use of captives:
- heavy and increasing premium costs in almost every line of insurance coverage.
- difficulties in obtaining coverage for certain types of risk.
- differences in coverage in various parts of the world.
- inflexible credit rating structures which reflect market trends rather than individual loss experience.
- insufficient credit for deductibles and/or loss control efforts.
Other Advantages of Captives
In many cases, Captives are used for hiding money from the IRS. This is done through self-insurance and the issuance of bogus and needless insurance policies by the parent company. Here's an example: Smith Dentists Inc. create an off-shore insurance company called Acme Insurance which in turn insures Smith Dentists Inc. for loss of employee wages, fire, loss of computer equipment, etc., etc. Acme Insurance then sets the premiums for these policies at $50,000. Smith Dentists Inc. pays the premiums and then deducts the $50,000 as an insurance cost from its taxes.
Main Captive Domiciles
| Domicile | Captive Number | Percentage |
|---|---|---|
| Bermuda* | ||
| Cayman Islands* | ||
| Vermont* | ||
| British Virgin Islands* | ||
| Guernsey* | ||
| Luxembourg* | ||
| Barbados* | ||
| Ireland* | ||
| Hawaii* | ||
| South Carolina* | ||
| Isle of Man | ||
| Nevada* | ||
| Arizona* | ||
| Turks & Caicos | ||
| Singapore | ||
| Sweden | ||
| Switzerland | ||
| District of Columbia | ||
| Utah | ||
| New York | ||
| Netherlands | ||
| Labuan | ||
| Vanuatu | ||
| Bahamas | ||
| Total |
*2008 Updated stats. Source: Business Insurance News Captives 2008[1]
Industry Resources
Captive.com
CICA
Captive Review
VCIA
Vermont Captive
Captive Insurance Alternatives
Captive Insurance
Taken Captive
Useful Articles
- Book: Taken Captive: How to Capture Your Piece of America's Multi-Billion Dollar Insurance Industry
- Long-term strategy is driving popularity of captives, says Aon
- Nevis Statutory Funds – Risk Segregation of a Different Kind, by Atlas Insurance Management
- What Is A Captive Insurance Company? by Risk Management Advisors
- Protection of Long-Term Policyholders Assets, from Atlas Insurance Management
- Captives: A Better Way to Fund Employee Benefits? R. Wesley Sierk, III
- Book: Adkisson's Captive Insurance Companies: An Introduction to Captives, Closely-Held Insurance Companies and Risk Retention Groups