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What is Captive Insurance?

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What is Captive Insurance? -  What is a  Captive Insurance Company ? 

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 his related companies. The insured businesses pay premiums to the Captive in exchange for insurance. The Captive can be owned by the business owner , his spouse, his relatives, a Trust, or any of the companies he owns.

Captives that are owned by US citizens account for approximately 3,500 of the nearly 5,000 Captives that are currently in operation worldwide. Captives can be domiciled and licensed in a wide number of domiciles both in the US and off-shore.  There are now approximately 24 US States  and well over 35 countries with Captive Insurance legislation that serve as excellent Captive Insurance domiciles. Captive Insurance Companies that are formed outside the US or offshore can make an IRC section 953(d) election to be taxed as a Domestic US corporation to US Tax purposes. This allows a foreign based Captive Insurance Company to receive the same  US Tax benefits and treatment as a Captive formed in any of the 24 US States with Captive Insurance Legislation. The big difference is that a foreign based Captive generally has a much lower costs of ownership and a far higher degree of flexibility for its US owners compared to a Captive which is formed in the US. For this reason most small Captive Insurance Companies with annual premiums below $1.2 million are formed offshore. The table below entitles " A List of US and Foreign (Offshore) Captive Insurance Domiciles" list the 24 US States with Captive Insurance Legislation as well as the 35 foreign countries which have Captive Insurance Legislation and serve as excellent Captive Insurance domiciles. By clicking on any domicile you can go to its government website for addition information including its Captive Insurance legislation and requirements. 

A List of US and Foreign (Offshore) Captive Insurance Domiciles

     
US Captive Domiciles Off-Shore Captive Domiciles
     
Alabama Anguilla  New Zealand
Arizona Australia Panama 
Arkansas Bahamas Puerto Rico
Colorado Barbados Singapore
Delaware Bermuda St. Lucia
District of Columbia British Columbia Sweden
Florida British Virgin Islands Switzerland
Georgia Cayman Islands Turks & Caicos Islands
Hawaii Curacao (Netherlands) U.S. Virgin Islands
Illinois Denmark Vanuatu
Kansas Dublin West Indies
Kentucky Gibraltar  
Maine Guam  
Montana Guernsey  
Nevada Hong Kong  
New York Isle of Man  
Rhode Island Jersey  
South Carolina Labuan  
South Dakota Liechtenstein  
Tennessee London - Lloyd's of London  
Utah Luxembourg  
Vermont Malta  
Virginia Mauritius (South Africa)  
West Virginia Nevis  
     

Captive Insurance History and development

In the last 20 to 30 years there has been phenomenal growth in the number of captive insurance companies so that today there are well over 5,000 captives worldwide writing more than $20 billion in premium. These companies have capital and surplus estimated at over $50 billion.

The captive insurance industry can be said to have its origins in the formation of mutual and co-insurance companies in the 1920s and 1930s. However, the start of the real growth of the captive industry can be traced to the early 1950s and the move by parent companies, to establish their captives offshore.

The greatest stimulus to the development of captives has been the expense or lack of availability of certain types of insurance coverage in the commercial market. Other considerations apply, however, and these have become so important in the minds of risk managers and finance directors that, even when commercial premium rates have been extraordinarily low, the interest in captives has been greater than ever.

Evidence of this interest is provided not only by the number of captives being formed but also by the increasing number of domiciles available for their incorporation. Long-standing domiciles, such as Bermuda, the Cayman Islands, Guernsey, the Isle of Man and Luxembourg have been joined by the likes of Vermont, the British Virgin Islands, Gibraltar and Dublin. In a move that demonstrates forcibly the emergence of captives into the mainstream of the insurance and risk management arena, the Council of Lloyd’s passed a byelaw in November 1998 permitting the establishment of captive operations at Lloyd’s.

Types of Captive Insurance Companies

There are several types of insurance captive, of which 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 company 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.

Reasons for forming a captive insurance company

Captive Insurance Companies are formed for a number of economic reasons with the main drivers being risk management and risk financing. Some of these reasons are summarized below.

  • Lower insurance costs. Commercial market insurance premiums must be adequate to meet the cost of claims but, in common with other commercial enterprises, insurers are in business to make money and will therefore include in the premium an element to provide for their acquisition costs, overheads and profit. This portion of the premium can represent as much as 35% or 40% of the whole. In establishing a captive, the parent seeks to retain the profit within the group rather than see it go to an outside party. A captive may also help reduce insurance costs by charging a premium that more accurately reflects the parent’s loss experience.

  • Cash flow. Apart from pure underwriting profit, insurers rely heavily on investment income. Premiums are typically paid in advance while claims are paid out over a longer period. Until claims become payable the premium is available for investment. By utilizing a captive, premiums and investment income are retained within the group and, where the captive is domiciled offshore, that investment income may be untaxed. Additionally the captive may be able to offer a more flexible premium payment plan thereby offering a direct cash flow advantage to the parent.

  • Risk retention. A company’s willingness to retain more of its own risk, particularly by increasing deductible levels, may be frustrated by the inadequate discount offered by insurers to take account of the increased deductible and by the fact that the company is unable to establish reserves to pay future claims. Establishment of a captive can help address both these problems.

  • Unavailability of coverage. Where the commercial market is unable or unwilling to provide coverage for certain risks or where the price quoted is seen to be unreasonable, a captive may provide the cover required.

  • Risk management. A captive can act as a focus for the risk management and risk financing activities of its parent organization. An effective risk management program will result in recognizable profits for the captive. Risk management can be viewed by a captive owner not as a cost centre but as a potentially profitable part of the company’s activities. A captive can also be used by a multinational to set global deductible levels by enabling a local manager to insure with the captive at a level suitable to the size of his own business unit while the captive only buys reinsurance in excess of the level appropriate to the group as a whole.

  • Access to the reinsurance market. Reinsurers are the international wholesalers of the insurance world. Operating on a lower cost structure than direct insurers they are able to provide coverage at advantageous rates. By using a captive to access the reinsurance market the buyer can more easily determine his own retention levels and structure his program with greater flexibility.

  • Writing unrelated risks for profit. Apart from writing its parent’s risks, a captive may operate as a separate profit centre by writing the risks of third parties. In particular, an organization may wish to sell insurance to existing customers of its core business. For example, retailers may sell extended warranty cover to customers with the risk being carried by the retailer’s captive. The claims pattern of this type of business is usually very predictable with a large number of small exposures and can provide the retailer with a valuable additional source of revenue.

  • Tax minimization and deferral. The tax considerations in forming a captive will depend on the domicile of both the parent and the captive. Integration of a captive as part of an overall tax planning strategy is a complex subject so that professional legal and tax advice is essential.

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