|
Why Form a Captive
A
captive insurance company lies somewhere between
self-insurance and guaranteed cost insurance on a
continuum of available risk financing techniques. To
assess whether a captive is the right risk financing
technique for a given situation, the potential benefits of
a captive have to be compared to both self-insurance and
traditional
insurance. The following ten benefits are most often cited
as the reason for forming a captive.
1. Insulation from market swings
A
captive has the advantage of being able to charge
consistent premiums and build surplus to insulate its
owners from market swings associated with commercial
insurance. A captive is able to do this in a more
segregated and formalized environment than self-insurance mechanisms.
2. Internal smoothing of deductibles
For
companies that operate on a decentralized basis, there
is usually a significant difference between the amount
of risk that can be comfortably retained at the
corporate level and the subsidiary level. To enable
these corporations to benefit from their overall
financial strength and reduce the amount of external
premium expenditure, an internal financing mechanism
needs to be created to protect subsidiaries within the
corporate retentions. A captive can be an ideal vehicle for this use and provides a
formalized program
to
transfer the fluctuation of corporate deductibles to a
captive subsidiary via the issuance of formal insurance
contracts.
3. Focal point for risk management
activities
A
captive can be used to increase the visibility of a
corporation’s risk management program. With senior
managers and even operating managers participating on
their Boards, captives can raise the level of awareness of
risk management at these levels and help create ownership
of the risk management program. A captive can also play a
central role in the gathering of risk and insurance
information for a decentralized organization. This is
particularly true for international or decentralized
programs where the captive’s participation in the
insurance program may allow corporate involvement without
disrupting local autonomy. These strategic benefits are
difficult to reproduce in traditional insurance and self-insurance
programs.
4. Coverage
Captives
have more flexibility in tailoring coverage to the needs
of their owners and providing coverage that is unavailable
or prohibitively expensive in the commercial market.
Self-funding these risks can also provide a financial
buffer to protect an organization, although the greater
structure of a captive may be more beneficial in creating
segregated reserves and securing reinsurance support.
5. Profit
Many
captives have a strong profit motive seeking to underwrite
customer or related party business. The captive can often
be an opportunity to sell a new service to an existing
customer base, for example extended warranty insurance.
Group captives often have a goal of extending beyond their
initial owners to use the expertise they have developed
within the captive and apply it to other peer
organizations. Agency captives are primarily motivated by
profit and seek to share in the successful underwriting of
the risks the agency places.
6. Access to risk transfer capacity
(reinsurance)
As a
licensed insurer, a captive has the advantage of being
able to access the reinsurance markets. This can
increase the potential sources of risk transfer capacity
and reduce the cost.
Direct access to reinsurance can reduce the frictional
costs, allow for payment of ceding commissions to the
captive and lower federal excise taxes paid on the transaction.
7. Tax advantages
A
captive has a potential tax advantage over self-insurance
in its ability to deduct premiums paid to the
captive. The tax treatment of captive premiums is an
uncertain and fluid area. Any captive owner should seek
advice from an insurance tax expert on the appropriate structuring of captive
arrangements and the likelihood of tax deductibility
before relying too heavily on this potential advantage.
8. Control over claims handling
Both
captive and self-insurance programs have the potential to
unbundle claims handling services with the owner/insureds
having control over the TPA contracts. For liability
claims the ability to have more control over claims
handling is attractive to many insureds. The extent to
which this can be achieved will depend to a large degree
on the fronting and excess insurance or reinsurance arrangements
supporting the program.
9.
Risk control incentives
Being
financially responsible for paying losses under captive or
self-insurance programs can provide a greater incentive to
prevent losses than under guaranteed cost insurance. The
strength of the incentive depends on the degree to which
the financial responsibility is felt by those most able to
prevent the losses.
10. Cost
A
captive is often seen as being able to lower frictional costs
and charge stable costs independent of the commercial
market. However the need for fronting and the opportunity
cost associated with the capital investment and collateral
requirements sometimes negate this advantage. Self-insurance
mechanisms should have a cost advantage over captives, due
to the management costs and capital investment associated
with captives. As a result captives are rarely the optimal
solution on cost alone. A combination of a captive program with self-insurance can
help mitigate frictional costs while proving additional
benefits.
The SRS Guide to Captives contains
historical information that may no longer be accurate. It
is for informational purposes only and does not
constitute advice. No
reliance should be placed on the information contained
within this portion of the site and guidance should be
sought from SRS regarding captives and alternative risk
solutions. No information contained in the SRS Guide to
Captives
may be reproduced or copied in any format without the
express permission of SRS.
|
|
