Captive 101 - General Information
The following is intended as a general guide to some of the key issues relating to a Captive Insurance Company or Captive Insurance Cell– referred to as a "Captive".
What is a Captive?
Who owns a Captive?
What risks can a Captive insure?
Is a Captive a legitimate insurance company?
Why have Captives developed?
What are its advantages?
What are its disadvantages?
What types of Captives are available?
Who would manage the Captive?
What does it cost to set up and manage a Captive?
What factors influence management fees?
Should there be a feasibility study?
What criteria should be used when selecting a Captive jurisdiction?
Is there any special commitment to a Captive?
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What is a Captive Insurance Company, who owns it and what risks can it insure?
- A captive insurance company is effectively an “in house” insurance provider. The general mechanics of captive insurance are relatively straightforward. A business, having identified a risk, provides for that risk by paying regular cash instalments (premiums) to an entity over which it has complete control (as opposed to a traditional commercial insurance company). A captive may insure all of a risk itself or it may reinsure via the reinsurance market (reinsurance is a means by which an insurance company can protect itself against the risk of losses with other insurance companies).
- The basic attraction of captive insurance is self-evident. One gets all the benefits of insurance coverage while retaining the benefit of accumulated premiums. If the anticipated risk does not materialise, accumulated premium becomes retained profit. If the risk does materialise, the entity’s risk is covered.
- So this means that the premium you pay into your own captive fund is available to you when you need it. And even if you don't ever need it you keep the profit.
- Captive insurance entities are suitable for insuring risk that the insurance market restricts, rejects, charges a higher premium for or provides no cover. Prudent business owners who want to stay in business not only understand their risk exposures but do something about financing them when the insurance market comes up short.
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Summary
- A Captive Insurance Company primarily insures the risks of its owners and sometimes related or affiliated firms.
- Captives are insurers owned by the insured and organized for the main purpose of funding the owner's risks.
- The class and nature of the risk will depend on its owner but a captive can insure any legitimate risk.
- A Captive Insurance Company is a risk management and financing vehicle that offers an alternative to conventional
insurance and also the opportunity to dovetail into an existing risk-financing (insurance) programme.
- A Captive may insure all of a risk or it may reinsure, some or all, through reinsurance.
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Is a Captive Insurance Company a legitimate insurance company?
- Captive insurance has become an integral part of the global insurance market; estimated annual premium flowing into captives is US$55 billion.
There are over 50 jurisdictions (including at least 25 States in the USA) that offers some form of captive insurance legislation.
- There are over 5,000 captives worldwide. Jurisdictions include the Cayman Islands, Vermont, Guernsey and British Virgin Islands, Bermuda, Vanuatu and New Zealand.
- Two of the leading captive insurance jurisdictions Bermuda and Cayman Islands have over 1400 and 500 captives respectively.
- In the South Pacific region Vanuatu is a captive domicile that has the following tailored captive legislation:
- The Protected Cell Act 2005,
- The Insurance Act 2005 and Insurance Regulations 2006
- Incorporated Cell Act 2009
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Why have Captives developed and what risks are they suitable for?
- Captives have developed over the last fifty or so years. Captive insurance entities are suitable for insuring risk that the insurance market restricts, rejects, charges a higher premium for or provides no cover.
- As a captive matures and its net worth grows, it becomes capable of retaining a greater proportion of its parent's risk(s). The increased use of a captive reduces the parent's dependence on commercial insurance leading to better management of the insurance cycle of rising and falling premiums.
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What are the advantages of a Captive Insurance Company?
- Ability to manage premium timing to match the cash flow of the owner
- Returning underwriting profit and investment income to the owner (that would otherwise end up with a commercial insurer)
- Policies can be better tailored to the needs of the owner/ insured including insuring risks not available in the insurance market
- Premiums can be based on a business’s individual risk profile as opposed to that of the industry
- Direct access to wholesale reinsurance (reinsurance is a means by which an insurance company can protect itself against the risk of losses with other insurance companies)
- Administration costs are transparent and controlled
- Owners are able to actively participate in decisions influencing its underwriting, operations and investments
- Allocating correctly business risk cost and tax efficiency
- Closer involvement in handling claims leading to improved risk control (through a better understanding of the operational risks in the business – risks can be reduced and/or eliminated)
- Improved negotiating position - as the captive's ability to absorb risk grows; it improves the parent's negotiating position with insurance and reinsurance markets.
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What are the disadvantages of owning a captive insurance company?
- The risk of financial loss to owners as well as financial gain
- May require an up-front capital investment *
- If not structured properly, may present uncertainty as to the tax treatment of premiums and captive profits
- Entry and exist cost* compared to purchasing insurance from the commercial market
- May decrease an owner's purchasing power for other coverage in the commercial market
- Requires management time to participate on the captive's board and manage captive investments
- Potential for inadequate loss reserves. When actual losses exceed initially expected levels, captive insurance companies might need additional funds to be allocated. If risks are not well-assessed initially, the captive owner could suffer adverse financial consequences.
- Dependency on service providers. The quality of service that a captive offers depends on the quality of third-party service providers that it utilises.
* creating a protected cell may be a more cost effective solution
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What Captive Insurance structures are available?
Captives can be structured in several different ways and depend on the risk & circumstances of the risk and the owners circumstances. Some examples:
- Single Parent Captives Often described as 'pure' captives, these are companies with a single owner to whom they provide insurance coverage. A risk manager or financial officer at the parent company usually monitors them. A domiciled captive insurance manager, such as Riskman International, manages the captive.
- Association Captives This type of captive is formed by an established association to provide insurance coverage for members. Ownership rests with the association or individual members. They usually have a financial expert at the association level with prime responsibility, or outsource this function to a management company such as Riskman International.
- Industry Captives Industry captives are owned by companies within the same industry that have come together to solve a specific insurance problem. The stockholders generally appoint a board of directors to whom the management company reports.
- Rent-A-Captive. Companies 'rent' their "balance sheet" to entities wishing to establish a self-insurance program but not their own captive insurance facility. A rent-a-captive company insures the risks of its members and returns underwriting profit and investment income participation to the insureds.
- Protected cell companies (PCC's) and Incorporated Cell Companies (ICC's). These structures enable cell owners (usually the insured client) to ring fence their premiums, capital and assets from other cell owners in the Cell Company.
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Who would manage the Captive Insurance Company or Cell?
It is normal for Captive Insurance legislation to require that all applicants for an insurance licence to appoint an authorised Insurance Manager who is a resident in the jurisdiction, with sufficient experience to represent the company and liaise with the Regulator including:
- Assistance in structuring the Captive and in completing the application
- Incorporation of the company
- Provision of a principal office
- Maintenance of books and records, submission of reports and information and documentation which may be required by the Regulator
- Preparation of policies and certificates of insurance or reinsurance
- Processing of claims data
- Arranging for and supervising the operation of bank accounts, accounting and audit services
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Fee guide
Riskman International usually works on a range of fees depending on the captive structure.
For example whether the Captive is a separate Single Parent Captive or a Protected Cell (which may be the most economic).
It may be negotiated on a flat fee basis or as a percentage of the premium turnover, with a minimum annual fee.
The fees below are only a guide and will depending on complexity of the arrangement.
| Description |
Fee guide |
| Feasibility study |
US$5,000 |
| Business plan |
US$5,000 |
| Management - own captive company |
US$15,000 - US50,000 |
| Management - protected cell captive |
n% of annual premium with a minimum of US$15,000 |
| Feasibility study and/or business plan cost may be negotiated into our management fee |
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What other factors influence management fees?
- The number of insurance policies issued
- Written through an owned captive or a protected cell captive
- Reporting requirements of the client company's parent or owners, in frequency and complexity
- Number of annual and other meetings Riskman is required to attend and/or prepare for and whether these require overseas travel
- Claims handling arrangements
- Arrangements for investment of funds
- Level of responsibility placed on Riskman
- Time forming the insurance company & the business plan
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Should there be a feasibility study?
A feasibility study is essential and will include:
- Premium volume that will make the captive financially viable
- Risk management process
- Commitment from the parent's management to support the Captive with adequate finance & expertise
- Availability of competent management services to operate the Captive
- The risk & circumstances of the client
- The most suitable structure for the Captive
- Source of business
- Classes of business to be written
- Actuarial report(s)
- Underwriting guidelines
- Policy limits
- Details of reinsurance program
- Claims handling
- Investment philosophy
- Financial projections
What criteria should be used when selecting a Captive jurisdiction?
- Application procedures
- Currency control
- Political stability
- Qualified service providers
- Financial and regulatory reporting
- Local director requirements
- Legislation - does it provide flexibility?
- Fee level
- Capital requirement
- Economic development
- Perception & reputation
- Taxes
- Good track record
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Is there any special commitment to a Captive?
A person or entity should only commit to a captive insurance company after all of these criteria have been researched, evaluated and benefits found for the client.
Expert advice to carry out the above feasibility study is available through Riskman International.