Captives
What is a Captive?
“An insurance company that provides insurance to and is controlled by its owners or insureds”
Future of Captive Market
- Growth in Alternative Markets Continues even with Softening insurance market
- Roughly 5000 Captive facilities worldwide with steady growth in the past 20 years
- Coastal Properties (Wind), Silica, Pollution, construction defect, and other uninsurable risks, continue to gain captive popularity
Types of Captives
Owned by or affiliated with the insured
- Group Owned Captives
- Single Owner Captives
Non-affiliated
- Rental Captives
- Segregated Cell Captives
Regardless of size, captive owners/insureds need:
- Entrepreneurial spirit
- Desire to take control
- Financial ability to take risk – at least $250,000 per occurrence
- Commitment to loss control and safety improvement
What is a Group Captive?
- “A group of companies join together to form their own (re)insurance company.”
- Members are both shareholders and policyholders.
- Ideal premium size is from $300,000 to $2,000,000.
Group Reinsurance Structure
Company Structure
Premium Structure
Group Captive Pros/Cons
Pros
- Partnering with Quality Business Owners
- Captive Ownership/Increased Control
- Underwriting Profit/Investment Income
- Heightened Focus on Risk Management
- Unbundled Claims
Cons
- Potential for Assessments
- Potential to Share Risk
- Potentially Higher “Pay in Premium” than Traditional Market
Rental Captive Definition
An alternative risk financing vehicle where an insured “rents” a captive facility that provides the opportunity for underwriting profit and investment income, along with greater involvement in claims management and program structure.
Rental Captive Reinsurance Structure
Rental Captive Pros/Cons
Pros
- Underwriting Profit/Investment Income
- Reduced Operating Expenses (relative to Group Captive)
- Less Governance Requirements
- Opportunity to Grow and Maintain the same Program
- Potentially No Risk Sharing with Other Companies
Cons
- Less Control than Other Forms of Captives
- Need Minimum Separate Sources of Risk
- May Not be able to Unbundle Claims
Single Owner Captives
- Set up to manage the risks of its owner
- Captives that insure only the risks of the owner or the owner’s subsidiary operations are termed “pure” captives
- Some single risk captives also provide coverage for other unrelated organizations
- The source of the risk is the owner’s primary business activity
- Financial results of captive will be consolidated with financial results of captive shareholder
- Premiums to captive must be adequate to support captive operating costs and pay retained losses
- Less than $1,000,000 becomes uneconomical
- Can insure all lines, including traditionally uninsurable risks
- Capitalization requirements based on domicile statute and amount of risk retained (on-shore vs. off-shore)
- Adequate capital required to take risk
- Must have enough separate sources of risk to meet IRS requirements for risk pooling – currently 7
Single Owner Pros/Cons
Pros
- Underwriting Profit/Investment Income
- Most Control
- Increased Flexibility in Program Design
- Unbundled Claims
Cons
- Cost of Ongoing Operating Costs
- Potentially Significant Amount of Capital Needed
- Need Minimum Separate Sources of Risk
The Tax Acceleration Effect
- Insured deducts premium as customary and normal business expense
- Self insured deducts loss when paid
- Premium insures losses that may be reported and paid in a future period
- The insurer is allowed to deduct reserves from income
- Discounted based on expected loss payout
Selecting the Type of Captive
- How many separately incorporated entities do you have?
- Do you want to deal with governance, have control over profit distributions?
- Do you want to share risk with other companies?
- Are you looking to transfer assets and liabilities into a non-consolidated entity?
- Note that “size” and “expenses” are not key drivers, but type of risk may be.