Introduction
Captive insurance companies are such specialized insurance entities created and wholly owned by a parent company or group of companies to provide coverage for their own risks. Rather than buying their insurance cover through commercial insurers, a big group often forms captive insurance companies so that they will be able to insure themselves on their own risks, control their insurance programs, and reduce the cost of insurance cover.
Captives are also very attractive to large business, because of scale and deep pockets that give them the financial capacity to self-insure. Such businesses may avail themselves of a captive as one means of fulfilling their specific insurance needs, managing risks more effectively, and deriving financial advantages that standard insurance markets do not typically offer.
The main features of a captive insurance company:
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Ownership: A captive insurance company is owned by the entity it covers. The company is its own insurer and thus manages and underwrites its very own insurance policies.
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Flexibility/Customer-Centricity: Captives allow flexible and custom insurance coverage to suit the parent company’s unique risks as they may not have been available from traditional insurance sources.
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Retained Premiums: The Captive pays a premium, but the amount would not be paid out to a commercial insurer. Thus this retained amount, by accumulation over time saves lots of amounts and builds the reserve for claims.
Captive insurance encourages better risk management at a level of the parent company because it allows the parents to have direct control over underwriting practices, claims management, and strategies adopted in loss prevention.
Types of Captive Insurance Companies:
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Single-Parent (Pure) Captive: Owned by one corporation and covers only the risks of its parent company.
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Group Captive: Several corporations, often in the same industry combine to form a captive, where the risks and profits are shared.
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Agency Captive: Started by an insurance agency or broker as a method of covering the risks of clients.
Benefits of Captive Insurance Companies for Large Business:
Cost Savings:
Reduced Premiums: Since a company avoids using traditional insurers, the cost of insurance in the future is reduced. Premiums that otherwise are paid to the insurers end up being retained in the parent corporation.
Profit Retention: Profits from commercial insurers are expected; however, captive allows profits from underwriting to be retained in the parent corporation, thereby further increasing the net saving.
Cash Flow Increase:
Captives can reduce cash flow by enabling the parent company to retain premiums, invest that premiums, and have more control over claims payments over time.
Claims are paid when the company requires them instead of the schedule of a third-party insurer, thus giving better control of management.
Tailor-made Coverage:
Large, unique, or complex risk profiles can be used to design policies tailored to a particular organization’s needs. It is very useful for risks that are hard or expensive to insure in traditional markets, such as cyber risks, product liability, or environmental risks.
It provides coverage for high-frequency, low-severity losses or emerging risks that commercial insurers are shying away from underwriting.
Direct access to reinsurance markets:
Captives can directly go to the reinsurance market; thus, they can acquire more layers of coverage at cheaper rates than acquiring it from commercial insurers.
Reinsurance will also enable captives to transfer risks above their retention level, which is thus the added cover to risks.
Risk Management and Control:
Captives compel a parent company to improve the general risk management practice because captive’s financial success is attached to the outcome of an insured company.
With captive fronting, full controls are achieved over claims handling and policy administration, making it possible for enterprise clients to tighten loss prevention schemes and lower the frequency and severity of claims.
Tax Benefits:
Premium payments to the captive may be tax-free under the jurisdiction in which the captive is formed, depending on its domicile .
Premiums paid to the captive could be tax-deductible while earnings from the captive build up tax-deferred, subject to applicable tax laws
Risk Retention increased
Captives enable large businesses to reserve a higher portion of their risk, which is substantial wherever third-party insurance is too cost prohibitive or unavailable.
Captives would then be highly effective in “hard” insurance markets where commercial market rates have become too high, or cover cannot be obtained.
Claims Handling:
Because the captive insurer shares the same interests with the parent company, claims handling is made more efficient while resolution is quicker, and disputes are less.
Direct control is exercised directly by the enterprise over the processing of claims, meaning there can be cost efficiencies and better outcomes for the company.
Coverage of Broader Risks
Captive insurers are able to cover non-traditional or emerging risks. Some of these risks include:
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Pandemic-related losses
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Environmental liabilities
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Cybersecurity risks
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Reputation damage
By providing for risk coverage not well insured in the traditional market, captives provide for broader protection of parent companies.
Long-Term Financial Planning
Captive insurance allows large enterprises to get a long-term outlook towards their insurance needs and also provides stability due to reduced reliance on volatile commercial insurance markets.
Building reserves within the captive also allows the parent companies to budget better and plan for future claims, leading to increased certainty around budgeting and financial planning.
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Rent-a-Captive: A business rents the license and services of a captive insurance structure without owning it; hence this allows more small businesses to enjoy captive solutions.
Conclusion:
Captive insurance companies can thus offer large companies very powerful tools to reduce the cost of insurance to thereby improve cash flow. In this regard, captives offer the businesses flexibility in designing their policies, direct access to reinsurance, as well as control over claims and risk management, which enable business groups to design flexible insurance programs according to their unique and specific needs. Although requiring a huge investment amount in the captive’s establishment, with respect to conformance to rules and regulations, captive seems to be an attractive option for large companies that require a substantially higher degree of control over their insurance strategies.