What is a Captive?

A captive insurance company is a legal entity formed primarily to insure the risks of one corporate parent or a number of similar corporations (e.g. trade associations), thereby contributing to a reduction in its parent's "total cost of risk." Captives are usually domiciled in a specialized location, either offshore or onshore, and sometimes write business unrelated to their parent. Captives are formed for many reasons, including the lack of a commercial insurance market for certain lines of coverage, the desire to recapture underwriting profits and investment income that would otherwise be earned by the commercial insurer, as a means to access the reinsurance market or, in certain circumstances, as a means of diversifying into insurance services.

Advantages of a Captive

The major benefits that the establishment of a captive brings to its parent can be divided into two main categories, financial and insurance.

Financial Advantages

• Reduced Insurance Costs – Most corporations do not retain as much risk as they are able to financially, and the commercial insurance market has high administrative costs which are passed on to their clients within the premiums charged. A captive can reduce the overall cost of an insurance program by retaining the premium for the expected losses, thereby avoiding the premium loading for a commercial insurer’s overheads and profits on this element of the overall premium.
• Improved Cash Flow – Premiums collected and reserves held for unpaid claims, otherwise kept by a commercial insurance company, can be held by a captive and invested. This takes advantage of an insurer’s ability to establish such reserves from pre-tax income that is not possible for a non-insurance entity.
• Matching of Revenue and Expense – With some types of coverage, particularly liabilities to third parties, losses may emerge over a number of years. A captive is able to reserve from current funds for future claims payments, thereby matching revenue and expenses attributable to each financial year.
• Performance Measurement – A captive is a trading subsidiary of its parent for which financial statements are prepared and consolidated with its parent’s. Thus, the financial impact of the parent company’s risk management program can be more easily monitored and evaluated and the captive’s performance measured in terms of return on investment or other financial criteria.
• Source of Additional Revenue – A captive can expand its book of business by offering insurance to related third parties, such as franchises, vendors, or customers, thereby generating an additional revenue stream for its parent. Some captives also write coverage for unrelated third parties through participation in various reinsurance pools or treaties.