Captive insurance companies or ‘captives’ are wholly owned subsidiaries of corporations that are used to provide those corporations with their insurance requirements. Companies have traditionally used captives to manage a variety of property and casualty risks. At the end of 1999 there were 4,355 known captives worldwide with an estimated $28bn of net written premium.
Traditionally, these captives have underwritten only their parent company’s property and casualty insurance. Recently however, there has been a growing trend for companies to use their captive programmes to fund and manage the risks associated with their employee benefits programmes.
Captives give companies, in a range of different ways, greater control and flexibility with regard to risk and the costs associated with it. Upon transferring its business risk to a captive there is usually about a 10–15% saving for a company on the basis of reduced charges to brokers, consolidation and pooling. There are, however, a number of other benefits companies can gain through the use of captives:
q Reserves on premiums The reserves held by a captive left over from premiums after deductions can be invested for the parent company’s benefit. Essentially the captive is allowing the parent to recapture the profits and money earned by the insurance company on the basis of favourable claims experience.
q Risk charges A captive insurer can determine the risk charges associated with its parent company based on that companies specific experiences. This can lead to the parent avoiding the effects of general market trends and enables the captive to, if necessary, moderate the adverse experiences of some of the parents subsidiaries in certain countries.
q Administration charges Captives allow their parent company to decrease that part of the premium associated with servicing, administration and profit. When insurance is taken out through a captive, the administration and profit loading can be replaced by a fronting charge. This generally saves the parent around half on these costs. With regard to servicing, there is usually an opportunity to negotiate lower servicing costs for things like claims management and premium collection.
q Location If a captive is covering an employer’s risk exposure internationally it should be based it in a country with the appropriate financial infrastructure and/or a low corporate tax regime, enabling the captive to reinvest a greater proportions of its working capital.
q Increased control A captive provides the parent with enhanced control in the face of changes in local markets. Captives allow companies to control rate increases which would otherwise be imposed by local insurers. By handling its risks through a captive, the company can actuarially decide whether rate rises are justified. Price fluctuations in the basic cost of insurance can, if the company so chooses, be absorbed by the captive and then the increased risk covered through additional reinsurance.
In addition to being released from the constraints of local price fluctuations, local insurers may be deficient in terms of offering the types of cover a company requires. A captive allows the parent to set up types of cover specifically tailored to its needs and non-commercially available types of cover.
Captives provide companies with a vehicle for providing their operating units with coverage for uninsurable, and difficult to insure risks. Funding of such risks can enable the captive to build reserves in the long term and, by diversifying the types of risk a captive is holding, to smooth earnings. Funding unusual risks is also easier for a mature captive program with significant underlying retention.
Local purchases of insurance are inherently more costly than ‘buying in bulk’, where savings can be found through lower premium costs and broader coverage. The use of bulk buying through a captive may also enable a company to access the reinsurance market directly for the costs of increasingly expensive premiums such as medical cover.