What is a captive?
A captive is an insurance company established by one or more organizations, and whose main purpose is to insure the risks of those organizations.
There are different types of captives :
- A single parent captive which insures related risks only.
- A group or association captive which is owned by the group or association members and insures the risks of the group or association only.
- An agency captive which is owned by an agency or broker which reinsures a portion of their clients’ risks.
- Open market captives which write unrelated business.
- Segregated account companies or protected cell companies, which provide legal separation of assets and liabilities of individual programs.
Why establish a captive?
Forming or participating in a captive can allow you to reap a number of benefits:
- Stable capacity – a captive can provide coverage for unusual and/or uninsurable exposures and can also eliminate cyclical pricing and capacity fluctuations inherent in the conventional market.
- Cost reductions – pricing in the conventional market includes profits and overhead. Although establishing a captive does not eliminate these costs, it should reduce them. And, depending on your loss history, there may be substantial underwriting profit.
- Cash flow – a captive will enjoy the benefit of investment income earned on funds supporting unearned premium and loss reserves, income which is usually enjoyed by the conventional market.
- Access to reinsurance – a captive has the ability to access the international reinsurance market, obtaining reinsurance protection which can be less expensive than conventional direct and umbrella coverage. In addition, a captive has the opportunity to reduce costs by combining multiple lines of risk, and may also earn ceding commission, profit commission or both.
- Unbundling of services – a captive will facilitate the unbundling of risk control and claims handling services from the actual purchase of insurance.
- Risk control discipline – a captive may instill an improved awareness of risk control within the parent organization, thus reducing insurance costs even further.
- Taxation – the establishment of a captive should always be determined by its validity as an insurance operation, independent of any tax advantage, which should be viewed as an incidental, but possibly significant advantage.
Prerequisites for Success
Many captives may fail even before they commence operations. To ensure the success of your captive, the following prerequisites should be in place:
- Management Commitment – it is crucial that the parent company’s management is committed to the captive, and understands and appreciates the captive’s role in the risk management function.
- Risk Control – there is a strong need for effective risk control techniques, which should ensure that, over the years, the loss experience remains far better than the industry average.
- Risk Identification and Evaluation – well-developed techniques for the identification and evaluation of risk should be used. In addition, the attitude of the organization toward retaining risk will be important when a decision is made on reinsurance and future development.
- Market Factors – the co-operation of the conventional market is required. A captive must have the ability to buy adequate and reasonably priced reinsurance.
- Management Services – it is essential that there are adequate management, legal and financial services available in the domicile selected for the captive.
- Group Captive – for group captives to succeed, there must be a long-term commitment from the members, adequate capitalization, selective membership standards, risk sharing, profit allocation and distribution plans, and exit strategies.