Captive insurance is an alternative to self-insurance in which insured parties establish a licensed insurance company for their own use and benefit.[1] The company focuses its service on the specific risks of the insureds and is incentivized to price the insurance near cost, since it has no separate investors. A captive insurance company helps its sponsors establish regular cash flow for their risks and offers them a direct choice of reinsurance. It also provides a tax benefit, since insurance premiums are a deductible business expense while directly held reserves are not.
When a company creates a captive they are indirectly able to evaluate the risks of subsidiaries, write policies, set premiums and ultimately either return unused funds in the form of profits, or invest them for future claim payouts.[2] Captive insurance companies sometimes insure the risks of the group's customers. This is an alternative form of risk management that is becoming a more practical and popular means[according to whom?] through which companies can protect themselves financially while having more control over how they are insured.[citation needed]
There are many variations of how captives can be set up, which can be broken into two categories. The first category is known as non-sponsored in which the company is the creator and beneficiary. Within that category the most common are single-parent or “pure”, group and association. The second category is sponsored in which the captive is owned and controlled by another company that allows other companies to “rent” insurance. This category includes Protected Cell Captive Insurers and Rental Captives.[3]
Origin of term
The term "captive" was coined by the "father of captive insurance", Frederic M. Reiss, while he was bringing his concept into practice for his first client, the Youngstown Sheet & Tube Company, in Ohio in the 1950s.[4] The company had a series of mining operations, and its management referred to the mines whose output was put solely to the corporation's use as captive mines. When Reiss helped the company incorporate its own insurance subsidiaries, they were called captive insurance companies because they wrote insurance exclusively for the captive mines. Reiss continued to use the term: the policyholder owns the insurance company i.e. the insurer is captive to the policyholder. If the captive insures its own parent and affiliates, it is called a pure captive. If it insures just one type of industry (e.g. energy industries), it is called a homogeneous captive. A captive insurance company can also insure a group of diverse companies; this is called a heterogeneous captive.
Bermuda is the world's leading offshore captive domicile. The onshore regulatory burden and the cost of operating either a US-based or Lloyd's-based captive in the early 1960s drove Reiss to seek out a jurisdiction that would allow his captive concept to flourish. After much investigation, he chose Bermuda, due to its geographical location, clean reputation and status as a British Dependent Territory, which avoided the risks and uncertainties often experienced by international businesses operating in politically unstable and unaccountable jurisdictions. Bermuda's captives are predominantly owned by large US corporations. The Cayman Islands is the second largest licensing jurisdiction in terms of the number of captives licensed. Vermont, in the United States, is second in terms of insurance company assets but third in terms of captives licensed. Healthcare corporations prefer Bermuda, due to the ease of claim payment provided by the regulatory environment.[5]
Luxembourg is the largest captive reinsurance domicile in the EU.[6]
A recent trend has various states in the United States revising their regulations to be more attractive to captive insurance companies. For example, Oregon has removed premium taxes from captives, instead charging a $5,000 annual fee.[7] In the United States, Vermont is home to more captive insurers than any other US state, with nearly 900 licensed captive companies as of August 2009.[citation needed] In past years, Anguilla was a fast growing offshore domicile which ended in 2013. More recently, Anguilla along with other offshore domiciles have seen few new formations and many liquidations and transfers. As with the BVI, ever changing applications of the regulations and the departures of well regarded regulators have ended Anguilla as a domiciles for new formations. Meanwhile, Montana,[8]Delaware, Tennessee, and Utah have been the fastest growing US domiciles.[9] In 2013, Texas[10] began allowing captives.
Captives may be licensed to write some lines of business directly. In other cases, such as workers' compensation in the US, for example, the business must initially be written by another insurer, under its insurance licence, which then reinsures it (lays it off) to the captive. The original insurer retains a fee, usually somewhere between 5% and 15%, to provide this service. Premiums paid to captives are tax deductible, provided the terms of the policy (including the premium amount) are reasonable. A captive cannot arbitrarily set the premium amount simply to generate a deduction for the parent. In most situations, the captive carrier should be able to demonstrate its premium generating process (underwriting).
In the European Union, a new set of regulatory requirements (Solvency II) is planned with additional restrictions and responsibilities for captives and reinsurance companies. Some European captives ask for simplified regulation.[12]
Captive manager
Reiss created the first captive management company, International Risk Management Limited (IRML), in Bermuda in 1962 to provide the administration of his client's captives (this is now part of the Aon Corporation).[13] Most captive management is usually outsourced to a captive manager located in the jurisdiction that holds the primary license for the captive.[citation needed]
In the US, most captive managers are small administrative services providers.[14] They don’t draft insurance policies, which is generally the function of a senior insurance or corporate lawyer; they don’t price policies, which is done by an actuary or underwriter; and they don’t purport to be responsible for state or federal tax issues, which is what a tax lawyer does. Other captive management firms provide a full turnkey service to include all aspects of forming and managing a captive insurer on an ongoing basis, which would include professionals that understand the insurance, tax, and legal aspects of a captive.[15] The middle market is the area of growth for captive managers because more than 90% of Fortune 500 companies already do captives, according to Capstone Associated Services Ltd.,[16] a comprehensive manager of small captive insurers with over 140 captives formed for the middle market in the last 15+ years.
Captive insurance companies are creatures of the Internal Revenue Code. Over 75% of the world’s captives are associated with the United States because these insurance arrangements are encouraged under the Internal Revenue Code. Because captives are sophisticated tax structures (having been the subject of dozens of cases and rulings by the IRS, the Tax Court and various appellate courts over the past 70 years) captive owners often engage tax professionals in addition to captive managers that simply provide administrative services.[17][18]
Micro-captives
Over 90 percent of Fortune 1000 companies and many successful middle market businesses have captives. Over half of all property and casualty premiums that are written, are written through captives.[15]
Under the US tax code, a Section 831(b) or "small" property/casualty captive, also known as a "micro-captive" is used by midsize companies looking for cost-effective ways to transfer risk.[19] Captive experts say an 831(b) introduces middle market companies to alternative risk transfer and its benefits, providing this class of insurance buyers a valuable cost-saving tool long utilized by Fortune 1000 companies. During the early 2010s The Section 831(b) captive or "small" property and casualty captive insurance became a popular choice for middle market companies.[20] This also led to a proliferation of captive insurance as an illegal tax shelter, whereby clients paid premiums up to the statutory deduction limit to entities that did not actually pool risk. The IRS took notice of these transactions and took a series of enforcement actions against them.[21][22]
Not listed above by Business Insurance News is Montana with 150 captives as of December 2013 and Anguilla which has more than 300 captives as of December 2012. Delaware does not report.
Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect against the risk of a contingent or uncertain loss.
Life insurance is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of an insured person. Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policyholder typically pays a premium, either regularly or as one lump sum. The benefits may include other expenses, such as funeral expenses.
Reinsurance is insurance that an insurance company purchases from another insurance company to insulate itself from the risk of a major claims event. With reinsurance, the company passes on ("cedes") some part of its own insurance liabilities to the other insurance company. The company that purchases the reinsurance policy is referred to as the "ceding company" or "cedent". The company issuing the reinsurance policy is referred to as the "reinsurer". In the classic case, reinsurance allows insurance companies to remain solvent after major claims events, such as major disasters like hurricanes or wildfires. In addition to its basic role in risk management, reinsurance is sometimes used to reduce the ceding company's capital requirements, or for tax mitigation or other purposes.
Self insurance is a risk management method in which an organization that is liable for some risk does not take out any third-party insurance, but rather chooses to bear the risk itself. When used prudently, the organization that self insures sets aside money using actuarial and insurance information and the law of large numbers so that the amount set aside is enough to cover the future uncertain loss. The advantage is that no premium has to be paid, but the organizations own assets are used to pay out claims or losses.
General insurance or non-life insurance policy, including automobile and homeowners policies, provide payments depending on the loss from a particular financial event. General insurance is typically defined as any insurance that is not determined to be life insurance. It is called property and casualty insurance in the United States and Canada and non-life insurance in Continental Europe.
Liability insurance is a part of the general insurance system of risk financing to protect the purchaser from the risks of liabilities imposed by lawsuits and similar claims and protects the insured if the purchaser is sued for claims that come within the coverage of the insurance policy.
Directors and officers liability insurance is liability insurance payable to the directors and officers of a company, or to the organization itself, as indemnification (reimbursement) for losses or advancement of defense costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers. Such coverage may extend to defense costs arising from criminal and regulatory investigations or trials as well; in fact, often civil and criminal actions are brought against directors and officers simultaneously. Intentional illegal acts, however, are typically not covered under D&O policies.
Financial reinsurance is a form of reinsurance which is focused more on capital management than on risk transfer. In the non-life insurance segment of the insurance industry this class of transactions is often referred to as finite reinsurance.
Marine insurance covers the physical loss or damage of ships, cargo, terminals, and any transport by which the property is transferred, acquired, or held between the points of origin and the final destination. Cargo insurance a sub-branch of marine insurance, though marine insurance also includes onshore and offshore exposed property,, hull, marine casualty, and marine losses. When goods are transported by mail or courier or related post, shipping insurance is used instead.
A segregated portfolio company, sometimes referred to as a protected cell company, is a company which segregates the assets and liabilities of different classes of shares from each other and from the general assets of the SPC.
Insurance law is the practice of law surrounding insurance, including insurance policies and claims. It can be broadly broken into three categories - regulation of the business of insurance; regulation of the content of insurance policies, especially with regard to consumer policies; and regulation of claim handling wise.
Gard is a mutual company and operates around the world within marine insurance. It is the largest Protection & Indemnity insurer of the 12 P&I Clubs that are members of the International Group of P&I Clubs.
Insurance in the United States refers to the market for risk in the United States, the world's largest insurance market by premium volume. According to Swiss Re, of the $6.782 trillion of global direct premiums written worldwide in 2022, $2.959 trillion (43.6%) were written in the United States.
An insurance-linked security (ILS) is a financial instrument whose value is driven by insurance loss events. Those such instruments that are linked to property losses due to natural catastrophes represent a unique asset class, the return from which is uncorrelated with that of the general financial market.
Insurability can mean either whether a particular type of loss (risk) can be insured in theory, or whether a particular client is insurable for by a particular company because of particular circumstance and the quality assigned by an insurance provider pertaining to the risk that a given client would have.
A risk retention group (RRG) in business economics is an alternative risk transfer entity in the United States created under the federal Liability Risk Retention Act (LRRA). RRGs must form as liability insurance companies under the laws of at least one state—its charter state or domicile. The policyholders of the RRG are also its owners and membership must be limited to organizations or persons engaged in similar businesses or activities, thus being exposed to the same types of liability.
Captive insurance structures can be classified into three main categories: Single Parent Captives, Group Captives, and Core Cell Captive Insurance Companies, also known as Cell Captives or Core Cell Companies.
The Nonadmitted and Reinsurance Reform Act of 2010 is a United States law regulating the sale of insurance in states where the insurer is usually not authorized to sell insurance. It prevents states other than the home state of a U.S. insurance company from imposing regulations or taxes on the sale of nonadmitted insurance.
Insurance in South Africa describes a mechanism in that country for the reduction or minimisation of loss, owing to the constant exposure of people and assets to risks. The kinds of loss which arise if such risks eventuate may be either patrimonial or non-patrimonial.
Internal Revenue Code (I.R.C.) Section 831(b) is a U.S. tax law that provides specific tax benefits to certain small insurance companies, often referred to as "micro-captives". Established to encourage the formation of small insurance companies, it offers an alternative risk-management solution that can supplement or even replace traditional insurance coverage.
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