What is a Captive?

A Captive Insurance Company is an insurance company that primarily insures the risks of businesses which are related to it through common ownership. For example, the owner or a group of businesses can form a wholly owned Captive Insurance Company for the purpose of insuring the related companies. The insured businesses pay premiums to the Captive in exchange for insurance. The Captive can be owned by the business owner (or their spouse, their relatives, or a Trust) or by a corporation, or any of the companies the business owner or corporation owns.

Captive formation benefits may be achieved by any number of circumstances which may positively impact your business group.

What is the primary focus and role of a Captive?

• To insure specified risks
• Determine the optimal level of capital needed to fund the captive
• Maintain the desired capital level should losses exceed expectations

Would a Captive Benefit You?

There are many benefits to using a captive insurance program that centers on providing the client with more control over his insurance and administrative costs, such as the return of potential underwriting profit and investment income earned on reserves. Other benefits can include:

• Lower transaction costs and administration expenses compared to traditional insurance programs.
• The net cost of insurance can be reduced through the retention of underwriting profit and the investment income earned on loss reserves.
• Ability to control the flow of funds maximizes the benefits of effective cash management and leads to a more efficient use of capital.
• Improved coverage by using custom design policies specially tailored to the needs of the insured for exposures that are either not available or unaffordable in the traditional market.
• Direct access to reinsurance markets wherein a captive can secure competitive bids from a broader market increasing the opportunity of negotiating price and contract terms.
• Provides multinational companies the opportunity to use the captive as a mechanism to better consolidate the insurance needs of their international operations into one coordinated program.
• Protection from pricing swings that periodically occur in the traditional market place, thus providing a more equitable rating, pricing and limits over the long term.
• Paying the losses only of its parent and affiliates, the captive provides a focus on improving safety and loss control programs since funds not paid out in losses are retained by the captive.
• Control over the timing and payment of claims.
• Through an independently managed captive program, a parent can retain the service providers of its own choosing and which are best suited to meet the client’s needs, such as: fronting carriers, reinsurers, claims specialists, loss control experts, managed care firms, investment advisors and bank relationships
• Potential tax advantages.

Why Would You Form a Captive?

1. Tax Advantages
   • You would never set-up a Captive for tax reasons alone.
   • Certain tax benefits may be available by utilizing a captive insurance company. Any tax benefits, however, should not form the reasoning behind the establishment of a captive insurance company.
   • Insurance companies are provided a special tax treatment; they can accrue tax-deductible reserves for unpaid claims, whether known or estimated.
2. Program Design Benefits
   • Flexibility - a captive can offer specifically tailored wordings in the structure of the policies.
   • Control – Control of underwriting, rates and forms, as well as control of claim settlements and investments.
   • Risk Management and Underwriting Profitability: Conventional insurance is typically provided on a guaranteed cost basis and there is little incentive to improve risk management, as there is no participation in the profitability of the insurance program. However, with a captive insurance company, the parent will benefit from good claims experience, and surplus in the company may be available to the parent by way of dividend. A captive can therefore provide great incentives to improve the risk management philosophy throughout an organization. A captive can act as a focus for risk management and risk financing activities of its parent organization.
3. Uninsurable Risks
   • Availability of Cover - Certain types of coverages are unavailable or difficult to obtain because of such things as historic loss experience for a sector or industry, such as medical malpractice. By setting up a captive, a business can insure such risks and obtain access to the reinsurance markets that may have greater appetite for a risk.
   • Coverage Provision - Captives can provide coverage to subsidiaries and members that are not available in the market place, such as punitive damages.
4. Cost Reduction (Fixed and Variable)
   • A corporation paying an insurance premium to a conventional insurance company contributes to the expenses of an insurer (including inefficient administration and other insureds' losses) and profits of the insurer. By establishing one’s own insurance vehicle, such costs and profits are subject to control within the same economic family.
5. Long Term Cost Stability
   • Lower Insurance Costs - this is achieved through no profit loading, elimination or reduction of broker commissions and lower administrative costs.
6. Direct Market Access
   • Underwriting Stability - A captive insurance company is less vulnerable to the cyclical nature of hard and soft markets that plight the conventional insurance market. A captive can aide a business that requires accurate financial projections.
7. Access to Reinsurance Capacity
   • Reinsurance is available to insurance and reinsurance companies only, and typical cost ratios associated with such reinsurance are far less than conventional "primary" insurers. By accessing a second tier of insurance products (through the establishment of a captive insurance company) a business can access a wider array of insurance products at more effective costs.
   • A captive can access the reinsurance market, which operates on lower cost structure than a direct insurer.
8. Profit / Investment income
   • Captives can provide less restrictive regulations on, and more opportunities with respect to, corporate investments.
   • Cash Flow - A captive allows an owner to control the investment portfolio to which the excess premiums are applied. It also allows the money otherwise paid to third-party insurers to remain in the same economic family, unless claims are paid.
   • Cash Flow - insurers rely on investment and underwriting profit to improve cash flow. Premiums are typically paid in advance while claims are paid out over a longer period of time. By utilizing a captive, premiums and investment income are retained within the group. The captive can also provide a more flexible premium payment plan, thereby offering a direct cash flow advantage to the parent.
9. Administrative Tool
   • Deductible or expected loss funding
10. General Insurance
    • ‘Defense’ of historical liabilities.
    • Risk Retention - a company can manage its own risk by increasing the deductible levels. These deductibles can be insured through the captive.