A captive insurance company is typically defined as a wholly owned subsidiary of a non-insurance related group of companies established with the prime purpose of insuring the group’s risks. There are two main types of captives: single parent or group, the latter typically owned by a number of companies with similar exposures. Captives can be used to provide coverage either directly or as reinsurance of a fronting insurer.
Rationale of a Captive
Traditional insurance is not always the most economical method of financing a group’s risks. When the risk profile is favorable or when losses can be calculated or forecasted in advance, risk retention or self insurance may be more advantageous.
Captives can be very beneficial; the most important advantages being :
- savings in insurance premiums spent underwriting
- profit retained within the group interest on premiums retained in the group
- cheaper overhead than those hidden in market premiums
- direct access to the more flexible reinsurance markets
- focus on risk management tax considerations
Prerequisites for captive formation
A captive is a risk financing instrument, however, which can only be used when the following requirements can be fulfilled :
- sufficient spread of risk
- sufficient premium volume
- favorable claims records (or at least calculable)
A captive will also need capitalization and will incur management expenses.
The establishment of a captive insurance company requires careful consideration and the decision should only be taken after an in-depth feasibility study, which should preferably consider at least 3 main elements
1. Insurance Considerations
It should be remembered at all times that captive insurance is regarded as one of the more sophisticated forms of risk financing but basically it remains self insurance.
Before deciding on the establishment of a captive a profound analysis of the group’s risks, claims record, risk management and risk bearing capacity should be made.
A typical feasibility study will at least comment on:
- the current insurance program
- claims statistics over a period as long as possible
- risk bearing capacity of the group related to turnover, profit and liquidity
- alternative risk financing systems
- reinsurance protection for the captive
- claims forecasting on basis of mathematical models
At least it should also be considered to establish the captive in the home country of the group, but very often local requirements of supervision by authorities, fiscal aspects and lack of professional management, direct the captive to a specialized captive domicile.
3. Management Services
Professional management of the captive is of the utmost importance and the (future) captive owner should satisfy himself that he is acquiring the best services available that provide not only the required insurance substance and administrative organization but also a good working relationship with the relevant supervision- and other authorities.
For more information, visit MCB website on risk management.