Captive Insurance Company - Explained
What is a Captive Insurance Company?
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Back To: INSURANCE & RISK MANAGEMENT
What is a Captive Insurance Company?
A Captive Insurance Company is a subsidiary company formed and owned by a company for managing the financial risks of the parent company. A Captive Insurance company insures the risks of its owner. It is a vehicle for self-insurance which is cost-effective and tax-effective. Captive Insurance companies are formed to meet the risk management needs of its parent company. These companies are typically established as an alternative to commercial insurance, enabling the parent company to retain the money that would otherwise be spent on insurance premiums. It is not only a way of managing financial risks more efficiently, but it also helps in accelerating the business objectives of the company. It provides stability in financial operations and decreases the volatility of cash flow of the parent company. Like any other commercial insurance company, Captive Insurance companies are also obliged to follow the state regulatory requirements.
How Does a Captive Insurance Company Work?
Captive Insurance Companies serve their parent company in several ways. Besides serving the purpose of traditional insurance programs by covering All Risk and Civil Liability of the company they may also cover the credit insurance, cyber risk, extended warranties, employee health insurance, and other benefits. Currently, some companies are even thinking of covering risk against new disruptive technologies including Blockchain and Artificial Intelligence. If a company depends on the commercial insurance market, they may have to compromise their coverage policy but with a Captive Insurance company at their disposal, a company can strategize the most suitable coverage plan for itself. However, a Captive Insurance company may prove to be disadvantageous for its parent company by creating volatility in their finance. This volatility may occur if the balance between the risk retained and the financial retention capacity of the company is disrupted. So, the market conditions, retention capacity, claims etc. are to be thoroughly analyzed before launching a Captive Insurance Company. Although the mutual insurance companies are theoretically owned and run by its policyholders but this right of controlling the company is seldom used. Generally, policyholders are asked to vote on the issues that need their intervention. Even on such occasions they are presented with a proxy and guided by the board of the company about exercising their voting rights. The policyholders ownership gets over as soon as the insurance period ends. Policyholders assets are not invested in the company and they do not have an active role in running the company. On the other hand, a Captive Insurance Company is entirely owned and controlled by its insured. Three main features of a Captive Insurance company are-
- The insured put their own capital at risk
- A Captive Insurance company functions outside the purview of the commercial insurance market
- The insured invests its capital to meet its risk financing objective.
A parent company needs to invest its own resources in the captive insurance company. They own the company and earns from its profitability. Whereas in a mutual insurance company the policyholders are technically the owners of the company and are entitled to earn benefits from its profitability but in practice, the companies accumulate their surplus instead of distributing them. The captive insurance companies are considered to be a part of the alternative risk transfer market. They do not participate in the commercial marketplace and thus are not protected by the traditional regulatory environments. State guaranty funds do not provide any protection for the captive insureds and insurers often have much lesser capital than the commercial insurers. The insureds put their own capital at risk to take the advantages of captive insurance. The commercial market may not always offer suitable products for a company's risk financing needs. In such scenarios, a company may consider creating its own captive insurance company. The reasons behind establishing captive insurance companies are high pricing of commercial insurance plan, limited coverage, and unavailability of a suitable plan in the market. There are mainly two types of captive insurers. When a captive insurer is completely owned, directly or indirectly, by its insureds it is called the Pure Captives. Sponsored captives are owned by parties unrelated to the insureds.
Single-parent captives are owned by only one company whom they provide the insurance service and the group captives are owned by multiple companies. A group of individuals or companies set up one single captive insurance company to have insurance coverage. Sometimes a group captive provides coverage to the insureds belonging to the same industry or having similar risks. Such group captives are known as Industrial insured group-owned captives. On the other hand, heterogeneous group captives are owned by the insureds from various industry groups. This type of groups captives may be a reinsurance pool. A reinsurance pool does not offer direct insurance, rather it reinsures the captives of its owner. It may also insure other insurers that agree to issue policies to the owners of the pool.
Sponsored captives have all the main features of a pure captive. The insured's capital is put at risk and it functions outside the commercial marketplace. But it is not created by its insureds and it does not necessarily pool their risks. It may keep separate underwriting accounts for each one. This type of captives is also known and non-owned or non-affiliated captives. It may be created by someone related to the insurance industry for their client or by someone completely unrelated. The sponsor pays the statutory or core capital for the captive. Many sponsored captives do not acquire the capital from the insureds rather they take an access fee from them. These are known as rental captives. In some domiciles, the underwriting accounts of the insureds are legally required to be separated and asset of one insured may not be used for paying the liabilities of other participants unless concerned entities are in agreement to do so. Such accounts are called cell account. This is the main difference between pure group captives and sponsored captives. In pure group captive, one company's asset is used for paying others liability as the risks are pooled but in sponsored captives, the accounts are separated. Sponsored captives are generally used by those companies who cannot afford to set up their own captive insurance company. Eventually, after accumulating surplus they may move forward to create their own pure captive insurance company. A Captive insurance company created by an association for the use of its members does not fall under the category of Sponsored captive. It is a pure captive, indirectly owned by the members of the association and they have the voting control. The association may finance the captive, but the association is owned by its members so in effect they are the owner of the captive.
- What is insurance?
- Captive Agent
- Independent Agent
- Captive Insurance Company
- Combined Ratio
- Claims Adjuster
- Capital at Risk
- Assigned Risk
- Incurred But Not Reported
- Qualified Actuary
- Cession (Re-Insurance)
- Burning Cost Ratio
- What is an insurance contract?
- Accidental Means
- Anti-stacking Provisions
- What is an insurable interest?
- What are the common categorizations of insurance?
- National Association of Insurance Commissioners
- Insurance Regulatory Information System
- American Academy of Actuaries Definition
- American Association of Insurance Services Definition
- American Council of Life Insurance Definition
- American Insurance Association Definition
- American Risk and Insurance Association Definition
- LLoyd's of London
- Associate in Insurance Services (AIS) Definition
- Associate in Loss Control Management Definition
- Associate in Marine Insurance Management Definition
- Associate in Personal Insurance Definition
- Associate in Reinsurance (ARe) Definition
- Associate in Risk Management Definition
- Associate in Commercial Underwriting Definition
- Associate in Insurance Accounting and Finance Definition
- Associate in Surplus Lines Insurance Definition
- Chartered Insurance Professional Definition
- Chartered Life Underwriter Definition
- Chartered Property Casualty Underwriter Definition
- Vehicle insurancePrivate Passenger Auto Insurance Risk Profile
- Underinsured Motorist Coverage
- Uninsured Motorist Coverage
- Omnibus Clause
- Health Maintenance Organization
- Capitated Contract
- Point of Service Plan
- Children's Health Insurance Program
- Disability Insurance?
- Credit Disability Insurance
- Life Insurance?
- Cash Surrender Value
- Absolute Beneficiary
- Acceleration Life Insurance
- Accelerated Benefit
- Accelerated Option
- Accelerative Endowment
- Charitable Gift Life Insurance
- Incontestability Clause
- Waterfall Concept
- Assumed Interest Rate
- Clean Sheeting
- Hazard Insurance
- Homeowners, Renters, and Fire Insurance?
- Participating Community (Flood Insurance)
- Insurance Considerations for Business
- Business Liability Insurance
- Commercial General Liability
- Liability Risk Retention Act
- Excess Insurance and Umbrella Insurance Policy
- Business Interruption Insurance
- Key Person Insurance Definition
- Own-Occupation Policy
- Self-Funded Health Insurance Plan
- Basket Retention Policy
- Commercial Blanket Bond
- Alternative Risk Transfer Market Definition
- Commercial Property Casualty Market Index Survey
- What are the primary obligations of the insurer?
- Earned Premium
- Reservation of Rights Letter
- Collateral Source Rule
- What are the primary obligations of the insured?
- Insurance Premium
- Affidavit of Loss
- What is the general structure of an insurance contract?
- Ambiguity Principle
- Accommodation Line
- What are the common disputed provisions in an insurance contract?
- Absolute Exclusion
- All Risks Clause
- What is required for the termination of an insurance contract?
- Risk Management
- Professional Risk Manager
- Associate in Management (AIM)
- Financial Risk Manager
- Forecasting (Business)
- Objective Probability
- Unconditional Probability
- Enterprise Risk Management (ERM)
- Operational Risk
- Business Recovery Risk
- Political Risk
- Asset Protection
- Performance Bond
- Barra Risk Factor Analysis Definition
- Above Ground Risk (Mining Industry)
- Bumbershoot Policy (Maritime)
- Abandonment Clause (Boat or Vessel)
- Bobtail Liability Insurance (Trucking Industry)
- Anti-Indemnity Statute (Construction)