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What Is Captive Insurance

A captive insurance company is an offshore vehicle within a corporate group, whose business is to insure some or all of the risks of the group. Captives may participate in a corporate group’s insurance and risk management programme as direct insurers of group companies or, where local regulations and other considerations require, as reinsurers. The group’s risks can be limited by the purchase of insurance above the limits provided by the captive or through the purchase of reinsurance for the captive. A captive may, subject to regulatory permits, offer cover for almost any type of insurable risk and may insure every risk of a corporate group or confine itself to certain categories of risk.

The importance of captive insurance companies can be gauged by the fact that 60 of the top 100 companies in the United Kingdom have already established captives. Captive insurance companies are normally incorporated in low tax areas. Generally speaking, it will only be worthwhile to form a captive where the company is able to retain sufficient premiums to justify the costs of formation and operation. The retained premiums can produce both underwriting and investment income. It is unlikely that a captive would be feasible where the premium retained by the company (less any reinsurance premium payments) is under £250,000. However, much depends on the nature of the insurance programme and its loss experience. A preliminary feasibility study would provide an initial indication of a captive’s potential. There are a number of reasons why captives may provide a better means of risk management than the conventional market.

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.

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.

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 necessay part of the claims handling procedures of commercial insurers.

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 principal advantages of forming a captive are:

• Flexibility in policy design, premium payment timing, and claims handling matters
• Access to the reinsurance market not normally accessible to non-insurance entities
• Participation in underwriting profits
• Accrual of investment income on outstanding claims
• Improved risk management and retention
• Cost stabilisation
• Provision of covers unavailable or overpriced on the conventional market
• Detailed investigations must be made on a case by case basis, in order to match the best risk management strategies and facilities with the requirements of the group concerned.