Captive Insurance as an Alternative Risk Management Technique

A captive insurance company is one that is owned by its parent and/or other similar parents for the sole purpose of insuring the parent’s exposures to claims of losses. Captive insurance companies are usually owned by a single organization, although, sometimes it can be owned by an association of similar types of businesses.

The captive issues policies directly to the insured or insured’s and provides the risk transfer mechanism that the insured or insured’s desire. Since the insured owns the captive insurer, the insured will be able to participate in all or some of the profits. On the downside, the insured will also participate in any and all of the claims and losses. Clearly captive insurers present the insured extreme control over the insurance underwriting, claims and investments. Captives are usually created in industry sectors that are considered high-risk or have high risk exposures for loss.

Most professional liability industries, such as doctors, attorneys, engineers, and other professional organizations have captive insurers for their member organization. Captives can also be formed to deal with catastrophic events that are reoccurring and somewhat predictable overtime. Usually you see this along the coastal waterways with the high wind exposure to loss on property accounts. As with a self-insured plan, which this highly resembles the company profits and commissions are savings that are passed through to the insured. In high risk industries by the nature of their business or because of high risk exposures of loss, captives can provide some continuity in insurance pricing overtime. High risk industries that have exposures to malpractice claims tend to go in cycles depending on laws and regulations and other in inherent global factors.

Businesses that are exposed to catastrophic damages such as hurricanes, earthquakes, floods and the like have losses that tend to come in climactic cycles over long periods of time. Captives can help prevent these premium highs and lows by stabilizing the premiums over time. Just like self-insured plans, there usually is a tremendous amount of capital that must be invested to make the program work. Thus entering and exiting a captive insurer can be complex and difficult just like a self-insured plan. The Captive has tax advantages by having your own captive insurer but it is highly regulated and normally the captive would need to allow outside businesses to access the plan in order to receive favorable tax deductibility of premiums.

Within this category of captive insurers there are legislative laws in place allowing risk retention groups to be formed. These groups operate as a sharing of mutual risk financing by insuring all of its owners. Risk retention groups can form quite easily with very little capital as long as the group is a homogeneous group of business owners.

• Usually depending upon the tax ramifications captive insurers can either be domiciled in the state where the insured is domiciled and thus this is called a domestic insurer.

• The captive insurer could be based in another state other than the insured State and this would designate the captive insurer as a foreign insurer.

• Finally, it might make sense to base the captive insurer in another country and that would give it the designation of an alien insurer.

Captive Insurance Company’s fill a certain niche and usually works well within the niche and not so well outside their niche.

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