Why Captive Insurance

It is popularly thought that a captive is primarily formed for the purpose of minimising incurred tax. However, captives are formed for other economic reasons with the main drivers being:

Lower Insurance Costs

Lower Insurance Costs

In common with other commercial enterprises, insurers are in business to make money and will therefore include in the premium an element to provide for their acquisition costs, overheads and profit in addition to the claims costs. The premium may therefore be loaded by up to 35% or 40% in order to meet such costs. With the establishment of a captive, the parent company retains these risks within the group thereby maximising profit within the group, both through the retention of good risks and through the control of costs. An additional benefit is derived from the fact that the premium charged will accurately reflect the group’s loss experience, thus avoiding any premium loadings arising from adverse market results.

Cash Flow

Cash Flow

In addition to pure underwriting profit, an insurance company derives income from investments as premiums are typically paid in advance while claims are paid out over a longer period. Until such claims become payable the paid premium is available for investment. The captive may therefore serve as a vehicle in order to retain premiums and investment income within the group. The captive may also be able to offer a more flexible premium payment plan to its parent company thereby offering a direct cash flow advantage.

Risk Retention

Risk Retention

Notwithstanding a company’s willingness to retain more of its own risk by increasing deductible levels imposed in the insurance cover, any cost benefit may be frustrated by the inadequate discount offered by the insurers. Establishment of a captive can help address this problem.

Unavailability of Coverage

Unavailability of Coverage

A captive may provide custom-made insurance products if the commercial insurance market is either unwilling to provide cover for certain risks or quotes an unreasonable price.

Risk Management

Risk Management

A captive company can act as a centre point for the group’s risk management and risk financing activities. An effective risk management programme will not only result in recognisable profits for the captive, but can also be viewed by the parent company as a potentially profitable part of the Group’s activities.

Access to the reinsurance market

Access to the reinsurance market

Through a captive, the parent company has direct access to the reinsurance market which operates on a lower cost structure than direct insurers thereby providing cover at more advantageous rates. By using a captive to access the reinsurance market the group has greater flexibility in determining the retention levels and insurance structure most suitable for its operation.

Writing unrelated risks for profit

Writing unrelated risks for profit

The parent company may wish to transform the captive into a separate profit centre by underwriting risks other than its own, such as risks related to existing customers. This will entail a migration from a captive company structure into a fully fledged insurance company.

Claims Resolution

Claims Resolution

Captive insurance enables complete control over the Group’s own claims. Claims may be settled early if desired, or completely repudiated if the claim is not a valid one. It also gives the opportunity to outsource the claims settlement process in the best interest of the captive and the Group.

Stabilisation of Pricing

Risk Retention

Conventional insurance markets will often set prices in relation to broad industry classifications, thereby failing to reflect key differences in loss experience among individual insureds. The result is price volatility based on general market conditions and the actions of other insureds. A captive eliminates insurance market cycles and provides the opportunity to price insurance coverage according to a stable and reasonable unique loss experience from year to year.