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Captive Insurance

Captive Insurance is a risk-financing method or form of self-insurance that involves the creation of a subsidiary entity that is organized to meet the insurance needs of the parent company or group of companies and sometimes the group's customer as well. The companies that form captives are often characterized by their considerable annual insurance premiums, complex risk profiles, vulnerability to premium volatility, unique risks for which commercial insurance may be too expensive of unavailable and their ownership of high-value assets.

Corporations form captives for many reasons:

• Realize reduced operating expenses including licensing and supervision fees, costs related to management, legal, audit and actuarial, and implementation costs.
• More stable insurance premiums.
• Access to the international reinsurance market.
• Greater control over insurance contract wording.
• More input over the captive's risk-financing strategies.
• Reaction to the insufficient financial strength and credit quality of commercial insurance companies.
• Control of the risk management and insurance interface between group headquarter and business units.
• Better management and approach to risk retention, risk capital allocation and risk tolerance.
• Inflexible credit rating structures which reflect market trends rather than individual loss experience.
• Reduces the uncertainties of the availability of commercial insurance and cost.

Captive insurers underwrite virtually every risk that a commercial insurer would underwrite including:

• Auto Liability
• Aviation
• Credit
• Directors and Officers Liability
• Environmental
• Errors and Omissions
• Financial Products such as mortgage insurance and Surety bonds
• Health and Medical
• Life
• Marine
• Professional Indemnity
• Product Liability
• Property Damage

Offshore Financial Centers such as Bermuda and the Cayman Islands are an attractive market in which to locate captive insurance companies. OFCs have designed their regulatory and tax laws to create a favorable low-cost business environment. OFCs generally have lower capitalization requirements and lower tax rates on investments and underwriting income.

Types of Captives

• Single Parent Captive — A Single Parent Captive is the most common structure. It is an insurance or reinsurance company owned by one company. It is formed primarily to insure the risks of its non-insurance parent or affiliates. It almost always does not write any other risk than the risks of its owner.

• Association or Group Captive — An Association or Group Captive is a corporate structure owned by a trade, industry or service group either through a formal association or an informal relationship. Its members are able to obtain insurance coverage or limits unavailable by commercial underwriters.

• Agency Captive — Agency Captives do not provide insurance for their owners. Rather an Agency Captive is a type of captive owned by an insurance agency or brokerage firm to benefit the insurer, agent or broker that owns the company. Agency Captives reinsure a portion of their clients risks through that company.

• Rental Captives — Rental Captives act as sponsor companies that provide captive insurance coverage to companies that are not large enough to justify the costs of creating their own captive. This service is provided for a fee. The Rental Captive isolates losses by creating separate books within its own structure for each participating company. This establishes a separate accounting basis for the insurance business attributable to each participating company. A major legal danger is inherent in the structure of a Rental Captive. At some level, the sponsored company has joint liabilities. Absolute protections from each and every creditor don't exist.

• Special Purpose Vehicles — Used extensively in the past for financing arrangements that meet narrow, specific or temporary objectives, SPVs have been used for catastrophe bonds and reinsurance sidecars.

• Segregated Protected Company or Cell — SPCs are similar to rental captives with marked differences. They are designed 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.¹ In an SPC, the captive creates cells within itself. While each cell must follow the established procedure for forming a single parent captive, these cells do not need ultimate regulatory approval. The captive forming the cells is responsible for compliance and regulation, legitimacy and competence. Cells are protected legislatively from claims by creditors of other cells within the sponsored company.

1. Captive Insurance