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. In the simplest terms, it is an in-house self-insurance vehicle. Captives usually represent commercial, economic and tax advantages to their sponsors due to the cost reductions they help create, the ease for insurance risk management and the flexibility for cash flows they generate. Additionally, they provide coverage for risks that are neither available nor offered in the traditional insurance market at reasonable prices, and allow the relevant group direct access to reinsurance markets.

The administration of a captive is usually outsourced to a specialised captive manager, who is often located in an offshore jurisdiction.

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 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.

Commercial Advantages and Issues

The key issue 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 cover 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.

Main Captive Domiciles

Industry Resources

Captive.com
CICA
Captive Review
VCIA
Captive Insurance Alternatives
Captive Insurance

Useful Articles

• Captive market remains buoyant, says Aon
• Long-term strategy is driving popularity of captives, says Aon
• Nevis Statutory Funds – Risk Segregation of a Different Kind, by Atlas Insurance Management
• Protection of Long-Term Policyholders Assets, from Atlas Insurance Management
• Book: Adkisson's Captive Insurance Companies: An Introduction to Captives, Closely-Held Insurance Companies and Risk Retention Groups

See also

• reinsurance
• catastrophe bonds
• reinsurance sidecar

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