Captive insurance companies, which are established to finance the risk of a parent group or groups and sometimes these groups’ customers, can provide advantages in risk management, insurance savings, wealth transfer and taxes. They are a form of alternative risk transfer used by major corporations, nonprofit organizations and medium-sized businesses.
How Does a Captive Work?
The owners of a group of businesses may decide to retain some of their own risk and form their own insurance company, called a “captive insurer,” instead of purchasing insurance from a third party carrier. This is an attractive option for companies who find a limited availability of certain types of insurance coverage in the commercial market or find that those coverages will be a significant expense. In some cases, the captive insurer may decide to insure the group’s customers as well. The primary jurisdiction in which the captive insurance company is organized is called a “domicile.”
Benefits of Captives
Captives can bring many benefits as alternatives to other risk financing plans. Properly structured, captives can bring the following advantages:
- Reduced cost of risk
- Cash flow benefits from captive
- Coverage not available from commercial insurers
- Direct access to the international market of reinsurers, which can be more flexible
- Increased bargaining power with commercial insurers (if the captive holds a percentage of insurance)
- Centralize retained losses spread throughout subsidiaries
- Cash flow advantages on income taxes—premiums paid to a captive insurer can be tax-deductible, depending on several factors:
- The transaction is a bona-fide insurance transaction under a defensible business plan
- The captive’s owner is organized such that subsidiaries pay premiums to the captive
- The captive writes a substantial amount of unrelated business, e.g., employee benefit business
- Ownership is arranged such that insureds are not the same as shareholders.