What is a captive?
- A captive is an insurance company that coverages the risks of your parent company.
- The captive is an alternative to traditional and commercial insurance as well as the reinsurance market
- It is a formalised form of self-insurance
- Among others, there are many different types of captive insurance, e.g., single-parent captives, protected cell companies (PCC) as well as special purpose financial captives (SPFC).
Why use a captive?
- Dependence on the commercial insurance market is reduced
- Risk costs are reduced
- More coverage is not available through normal insurance policies
- Reserves are not tax-deductible
- Reserves can only be taken if a specific claim is at risk
- Premiums paid to the captive are tax-deductible
- Losses are immediately deductible by the captive
- Credit losses due to “work shifts” accelerate tax deduction
- Access to the reinsurance market
- Fewer government regulations and interventions
- Possibilities to modify the insurance programme yourself
- Advantages in underwriting risks
- Coveragee can be easily adjusted to include new buyers, new policies, other existing policies and possibly higher limits
- Improved claims handling possible
- Tax advantages
Who should use a captive?
- Large companies traded on the stock market
- Small, owner-managed companies
- Subsidiaries that have specific requirements
Incentives for small captives
- Premium income < USD 1.2 million, actuarially exempt from income tax
- Premium income > USD 1.2 million, accelerated deduction and higher reserves
Where can a captive be used most effectively?
- A captive should be domiciled in a country or US state where a regulatory insurance environment has been created that favours captive insurance companies
- Typical places of incorporation are Vermont, Ireland, Luxembourg, Bermuda, Jersey, the Isle of Man, Guernsey, the Cayman Islands, Singapore and sometimes the Netherlands
Disadvantages of a captive
- Costs for the implementation of the captive
- Costs for the administration of the captive
- Need for insurer to approve captive credit risk; may require additional collateral
Example – What happens in the event of a claim?
- 17.5 million USD claim; 500 TUSD deductible in an insurance policy
- The Insurer will indemnify $15.3 million ($17 million X 90%), subject to the terms and conditions of the policy
- The insurer is fully indemnified by captive, no risks
- Captive in turn, claims USD 10.3 million (USD 15.3 million – USD 5 million deductible at captive)
What form of management company should one use?
Contracting with an external captive manager is the most common form. Management companies are mostly owned by large insurance brokers, independent firms (not affiliated with insurance brokers), reinsurance companies, and less frequently by law firms.
Insurance brokerage management companies
Large insurance brokers can provide captive management services in all large and important “captive domiciles” (see above) to help your client establish a captive.
Independent management companies
Independent management companies have no relationship with large insurance brokers or insurance carriers. The advantage is that you can change your insurance broker without losing your captive management without any risks.
Management companies of reinsurers
These management companies offer the option of using the existing reinsurance service.
Captives can also be run by law firms. This is usually the case with start-up captives waiting to appoint the current captive manager or captives that are inactive or have little to no activity. Law firms do not have the same full-service capabilities that management companies of any kind (see above) can offer.
Very few captives are self-managed. Mostly it applies to captives that are either very large or can afford their full-time staff. The reason for this rare form is that most domiciles require that the books and records are looked after or handled locally. Accordingly, the staff must live and work on site.
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