What is Captive Insurance? What are its Benefits?

In general, a captive insurance company is an insurance company owned by the insured. This trend started in the late 1950s and continues on to today. One of the primary reasons captive insurance started is certain types of businesses couldn’t find insurance at affordable rates – if at all. Therefore, they started their own insurance company.  

What is Captive Insurance?

What are the Benefits of a Captive Insurance Company

A captive insurance company is generally described as an insurance company formed by an industrial or commercial company primarily to insure some or all of the risks of its parent or associated companies. Like any other company, the captive insurance company will be capitalized, have Directors and will employ managers who carry out the day to day running of the company.

Types of Liabilities

There are many different types of business liabilities for which a policy can be issued that must be considered when creating captive.

Liability for Advertising – This includes false advertising.

Antitrust and unfair competition – Being overly competitive or practicing dishonest practices can lead to liability.

Commercial vehicle insurance – This is the most common occurrence associated with the use of company vehicles by employees. Claims can be filed both from the employee who will drive the specified vehicle, or from a third party who was injured by the employee,

Construction and design problems – The company can receive assistance several years after the completion of work on the elimination of construction defects.

Structural Defects – Everyone involved in the construction of a home / project will be held liable if a claim is filed. Architects, engineers, builders, contractors, and even vendors who provided materials for a project can be names in a suit.

Title insurance – the documents may be incorrect, therefore, in the event of problems with the title, a claim may arise.

You don’t need to worry about your business as long as you have a captive set up correctly by an experienced professional captive insurance professional like Steele Larson Advisors. They can help you and answer any questions you may have.

Business Liability Information

Captives are known for saving companies money when buying insurance. Every company is exposed to various types for liabilities. Unfortunately, some companies more than others depending on the type and size of the company. 

Most companies have coverage for the “normal” risks for that type of business but lack coverage on other risks that we don’t normally think of. There is a way to draft several different policies to help cover these risks.  Here are a few options:

  • Litigation Expense Policies

This is in the event you are ever subjected t litigation you will have coverage which would pay for your legal fees and expenses only. The litigation expense policy (LEP) is usually used with captives so that no large asset becomes available to creditors.

  • Direct Policies

This would directly pay claimants and pay your legal defense fees and expenses. This type of policy is not preferred for captives since they potentially create an asset for plaintiffs to chase.

  • Policies of Indemnification

This would indemnify you for claims only (if you decide to make a claim) and pay your legal defense fees and expenses.

Sadly, many insurance managers simply copy their policies from a form or book or copy commercial policies without giving any thought to the peculiar needs of that particular captive to cover.  Make sure you are working with a Captive Insurance Company that has experience and can sit down and talk you though all the different options.

Captive Policies

Reiss conceived the captive to provide his clients with the insurance coverage they needed but could not get in the traditional insurance market, thereby reducing the high cost of insurance for large corporations. 

Almost simultaneously, he recognized tax advantages under the concept of the 1962 U.S. Tax Reform Act. Tax advantages often attracted corporations to form captive companies solely to reduce taxes, but over the years the business objectives of creating a captive company remained long after taxation. there was no loophole. 

Companies are turning to captives to cut costs, improve risk management, gain more control over their insurance, and gain direct access to the reinsurance market. Today captives are created to insure a wide variety of risks. 

Virtually every risk guaranteed by a commercial insurance company is covered by a subset of captive insurers. 

Examples include: property, workers’ compensation, accidents (general and automotive liability, product liability), and employee benefits such as long-term care plans and supplemental life insurance.

Most often, captive insurance is used to provide liability coverage for those lines of business, such as compensating workers who have regular and predictable loss payments, and to cover professional working-level liability for accessing the reinsurance market, including Lloyd’s syndicates, for redundant protection that may not be available or costly at the primary level, such as product liability, general and professional liability, and directors and officers. 

Vehicle insurance, both property damage and civil liability of corporate vehicle fleets and vehicles, is also quite common.

What are the Benefits of a Captive Insurance Company?

Capture underwriting profits. Conventional insurers aim to make an underwriting profit, it makes sense for insured companies to retain the underwriting profits made in the years of normal losses themselves by writing the insurance in their captive, and protecting the captive against a catastrophe through reinsurance. 

By using a captive, a company will not be penalized if the industry pricing is influenced by the poor claims record of others in the industry. Where companies have a better than average loss experience, their premium costs will reflect this.

Smoothing the cost of premiums. It is well known that premiums in the conventional market follow a cyclical pattern leading to budgeting and cashflow problems. 

A captive allows companies to decide at what level they wish to participate in the conventional insurance market and hence what level of premium to pay for risk transfer.

Niche products underwriting. The conventional market may not meet the needs of the parent company: often the underwriter will not or cannot offer the cover required. In this case the captive may be able to offer the cover, buying reinsurance to protect itself against a catastrophe.

Contingency reserves. These can be built up in a captive which will protect it against a higher than expected level of claims, or offer cover to the parent company against losses that may be low frequency but high severity, or offer cover that would not otherwise be available in the market. Being located in a low tax jurisdiction, certain tax benefits may be achieved.

Access to the reinsurance market. Often known as the “wholesale market”, this market offers cover to insurance companies and as such tends to have lower overheads, such as marketing related costs. 

As a result, it can often offer lower terms than the conventional market, and will sometimes pay commissions back to a captive for producing the business.

Risk Management Focus. Information focus, risk retention, relating operating companies’ premiums to their own loss experience: the captive may have a role in these and other areas.

When should you consider a captive or a captive management company?

It is difficult to define simply when a company should consider forming a captive, as every company and their needs are unique. In general terms companies which benefit from captive insurance tend to have common features. These include companies with:

  •     profitable net premium income exceeding £500,000;
  •     a Risk Management focus;
  •     loss history which is better than others in the same industry;
  •     low frequency, high severity risks and/or those that are suitable for excess of loss reinsurance, (lower levels of risk could be retained in the captive); 

Captive Domiciles

There are many places around the world where the economic environment is welcoming and conductive to the specific area of captive insurance. 

Whether you are looking to set up your own captive management company or are simply looking for a management company to manage your insurance risk these domiciles are the places to look. 

I’m sure most of the names will be familiar to those who have dealings with the offshore finance sector, some of the most well-established captive domiciles include the Isle of Man, Jersey, Guernsey, Bermuda, Hawaii and Cayman. 

Depending on whether you are based in Europe, the United Kingdom or the US one of these areas should be able to provide a service that will meet your captive insurance needs. 

Where to Set Up Your Captive?

“Where do I form a Captive Insurance Policy” is one of the more popular questions we are asked.   Timing is everything and where you set up your captive and when could be the most important.  

Once you have taken care of issues like capitalization, structuring, and tax issues then issues of domicile may be considered.

Domicile is where the captive is formed and licensed as an insurance company.  Once your captive is formed and licensed, it may then become an admitted carrier in any other jurisdiction where it applies for an insurance license.   

Unfortunately, many people desiring to form a captive insurance company start thinking of domicile first.  You don’t want to do that. You need to get all your ducks in a row first.

The truth is that most domiciles are about the same on paper.  Each one usually just copies the next to try and stay up to date and to try and keep in competition with their neighboring domiciles.  

Because they all are so similar decisions on where to set up your captive need to be looked at closely by someone who is familiar with the different policies of all the neighboring domiciles.  

Have your financial advisor look at all the domiciles in your area to see which one best fits the need for your captive insurance company.

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FAQs

Q1. What is a Captive Insurance Company?

Case law defines a captive insurance company as a “wholly owned insurance subsidiary.” In less formal language, a captive is an insurance company that you own.

Q2. Why Would I form a Captive?

To cover risks that aren’t covered by traditional insurance polices

Q3. Aren’t My Current Policies Adequate?

Probably not. Most commercially available policies have significant and well-known exemptions.  

Q4. How Long Have Companies Been Doing This?

The first captives were formed in the 1950s because companies couldn’t find insurance coverage for certain risks. The practice is now widespread; there are more than 5,000 captives worldwide and over 30 US states have legislation allowing for the formation of a captive insurance company.

Q5. What are the potential benefits of creating a captive?

  •     Tax cuts
  •     Improving corporate cash flow
  •     Building more asset protection
  •     Strengthening control over business risks
  •     Lots of real estate planning options
  •     Accelerated accumulation of wealth

Q6. How does a captive help reduce taxes?

Section 831 (b) of the code allows a prisoner to receive up to $ 1.2 million a year in insurance premiums – completely tax-free. This means that the premium paying company will deduct up to $ 1.2 million a year for insurance expenses, but that amount is not taxable for captive.

Q7. How does a captive corporate increase a company’s cash flow?

With a captive, a business can withhold dollars of insurance premiums usually paid to a third-party insurance company as part of a business venture. This provides many benefits, including improved cash flow and the availability of investment income.

Q8. How does the captive better control business risks?

A captive insurance company can provide better control over claims, increase insurance coverage, increase the flexibility of underwriting, and provide access to the reinsurance market.

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