Captive Insurance. What is a Captive Insurance Company?. It is an insurance company Limited-purpose, wholly owned entity whose primary function is insuring exposures and risks of parent, designated affiliates or subsidiaries.
Coverage availability: Captive owner has greater flexibility than with cost cap or finite options in design of insurance program coverage.
Cost efficiencies: Typical commercial insurers premiums have expense ratios of 30-40% of premium, including profit and loss provision.. Captives expense ratios are 10-15%, or less.
Investment: Captive has greater flexibility over cost cap or finite in selection of investment manager and choice of investments.
Reinsurance costs: Captive has access to higher limits at lower cost by purchasing limits directly from reinsurers.
Tax savings: With a captive, the entire premium is tax deductible. Captive structure allows accelerated deduction for losses (captive is able to establish reserves for the majority of ultimate projected losses on its income statement rather than when losses are paid).
Greater control: Captive owner determines what risks are covered, retentions, limits, and when premiums are paid. (Whereas the finite program provides a guaranteed investment return, a finite’s investment and inflation assumptions are typically more conservative than prevailing market yields would justify.)
Reduced fees: No excess and surplus lines tax of cost cap program, reduced broker fees.
This form of the captive has the greatest degree of program control:
Domiciles have developed unique expertise to support certain classes of business risks. For example:
Cayman Islands: Health care.
Bermuda: Derivatives, reinsurance, ART. Bermuda allows captives for environmental liabilities.
Vermont: Popular with companies that do not want to leave U.S. Vermont will allow captives for environmental risks.
A captive is structured to pre-fund “working layer” of expected losses. For cost exposures above that, the captive purchases insurance directly from reinsurance company.
In general, due to the working layer of loss in a captive, the cost of reinsurance is lower than comparable cost cap commercial insurance (which includes cost of insurance and reinsurance).
The most important tax question for a captive owner is whether the entire amount paid to the captive is treated as premium and is therefore tax-deductible. Two important considerations in establishing deductibility:
All funds paid out in claims are tax deductible eventually. Issue is the timing of the deduction.