First Things First: What is a Captive?
Updated: Feb 8, 2021
As organizations continue to experience the relentless increase in commercial insurance premiums and new limitations on coverage and availability in the ongoing hardening of the market, they have shown an increased interest in exploring captive insurance programs as an alternative to transferring risk to commercial insurers. This article which gives a high-level description of captive insurance companies is the first in an upcoming series on captive insurance structures.
Most organizations use a combination of risk retention (deductibles) and risk transfer (insurance) to finance insurable loss exposures as they diversify retained risk and administer retained losses. With the challenges of the current insurance market, organizations are taking a fresh look at their retention strategy. Using a captive insurance structure is the most formalized tactic available within a broad risk retention strategy.
What is a captive?
A captive is a licensed special purpose insurance company formed to insure or reinsure certain risks of its owner(s). It is subject to regulatory authority and review in the domicile (e.g., Bermuda or Vermont) in which it is formed and must adhere to the regulatory capitalization and premium requirements. Beyond that, the owners control all the underwriting, claims, investment and financial decisions in accordance with an approved plan.
If you decide to create or join a captive to insure certain assets or aspects of your operations, you will be in the insurance business and your own capital will be at risk.
captive as a risk financing tool.
A captive insurance company does not automatically save money. The savings are largely a result from risk retention. A captive does not deliver the immediate cash flow relief that may be available in other risk retention tactics. The savings are a function of:
· increasing retention and reducing commercial premium
· reducing net expenses and
· reducing losses retained in the plan
The structure and discipline mandated by the regulatory requirements for captive insurance companies results in better recognition of loss exposures and appropriate reporting of incurred losses which can help the organization with its risk assessment and mitigation strategies.
Other Potential Benefits
· Reduced reliance on commercial insurance
· Stability of cost of risk over time (and improved budgeting)
· Improved coverage and/or increased limits
· increased formality and allocation of cost of risk across an enterprise
· Potential tax efficiencies
In the arsenal of risk retention tactics and, faced with an appropriate exposure for formalized retention, an organization that forms a captive insurance company may realize financial benefits if it is prepared for a long-term commitment and deployment of its financial resources. The application of a captive approach depends on a thorough understanding of the underlying loss exposures and the various alternatives for financing the risk. It is not a silver bullet for every insurance or risk management problem.