Captive Insurance Companies: Your Risk Management Angel

Article excerpt

In Brief

Doing Your Own Thing

Companies are always evaluating the options available to meet their insurance needs, and more and more organizations are seeking alternatives to traditional coverage. A captive insurance company offers a nnmber of advantages and may provide a tempting alternative to purchasing insurance from conventional insurance companies. Captive insurance companies are often less regulated than conventional insurance companies,

and domestic captives are taxed differently for both Federal and state purposes. Businesses considering forming captive insurance companies have to analyze the tax and financial consequences of such a move, select a location that best suits their needs, and determine whether establishing a pure or group captive is more appropriate.

A captive insurance company is a closely held insurance company whose business is primarily supplied by and controlled by its owners. Captives are insurers owned by the insureds and organized for the main purpose of self-funding the owners' risks. The shareholders/insureds actively participate in decisions influencing the underwriting, operations, and investments of a captive insurer. Most jurisdictions allow two types of captives:

* Pure captives, entities wholly owned by one parent and its affiliated companies, and

* Group captives, entities owned by a small number of substantially sized, unaffiliated entities that are generally in the same type of business, e.g., accounting firms.

Advantages of Captives

As the worldwide business community becomes more sophisticated in analyzing and understanding risk exposures and the available alternatives for risk management, captives can often provide an attractive alternative to purchasing insurance from conventional insurance companies.

Captives can be organized for any number of reasons. They are used by many Fortune 500 companies and some much smaller enterprises. Captives' parents are engaged in all types of business activity: industrial, energy, medical, retail, and professional.

Some of the reasons for forming a captive include the following:

* To meet unique insurance needs;

* To provide a self-funding mechanism;

* To reduce the impact of the insurance industry's underwriting price cycles;

* To take advantage of the favorable experience and thereby reduce the cost of managing their risk. Conventional insurers may not take into account the full effect of an insured's good experience when pricing risk. Companies with low loss ratios on property risks may pay premium rates very similar to those of their competitors with high ratios;

* To provide opportunities for the organization to improve risk controls by centralizing the risk management function; and

* To increase control over funds flowing through the organization, through possible tax benefits and a reduction in the cost of risk management.

Regulation

Captives are generally subject to less regulation than conventional insurance companies for the following reasons:

* The owner of a pure captive must be a large sophisticated financial entity-measured by a minimum net worth and meeting other application criteria

* Captives are self-insurers: They exist to cover the parent company's risks.

* Captives cannot sell direct coverage to persons or entities other than their owners and affiliated entities

* Captives cannot provide direct coverage, even to their parents and affiliated companies, if such coverage is required by law (e.g., workers' compensation or automobile liability).

Current State of the Captive Market

The total amount of premiums written through the captive insurance market is sizable and growing. Based on the captive insurance directories issued by Tillinghast-Towers, in 1997 total premiums were $18 billion, capital and surplus were $45 billion, and investable assets were almost $104 billion. …