Key Characteristics of a Captive Insurance Company (2024)

The firm routinely forms, manages, and advises captive insurance companies. While they are more commonly utilized by large corporations or groups of companies with substantial risk exposure and financial capabilities, they can also be highly beneficial for smaller entities, particularly in the healthcare and auto markets. This article, the first in a series we’ll be publishing, provides an overview of the key characteristics of a captive insurance company.

What Is a Captive?

A captive is a type of insurance company that is wholly owned and controlled by its insureds (the policyholders). It is established by a parent company or a group of related companies to provide coverage for the risks of the parent company and its affiliates.

What Is the Purpose of a Captive Insurance Company?

The primary purpose of creating a captive insurance company is to gain more control over the insurance process and risk management, as well as potentially reducing the overall costs of insurance. Instead of relying on traditional commercial policies, which may not fully meet the specific needs of the parent company, a captive allows for tailoring insurance coverage to match the company's unique risks and risk appetite.

What Are the Key Characteristics of Captives?

Certain fundamental features of captives make them a strategic alternative to traditional insurance. These characteristics encompass areas of control, customization of coverage, risk mitigation, cost savings, preferred domiciliary, and loss mitigation.

The parent company or group of related companies own the captive, giving them direct control over the insurance decisions and underwriting process. Captives offer tailored insurance coverage for the owners, allowing the parent company to include specific risk exclusions or inclusions that may not be available in the traditional insurance market.

Captives are effectively a risk management tool. They are primarily established to manage and finance the risks faced by the parent company or its affiliates. They can cover a wide range of risks, such as property damage, liability, employee benefits, and even more specialized risks.

Additionally, by operating a captive, the parent company can potentially save money on insurance premiums and access favorable tax treatments, depending on the jurisdiction where the captive is domiciled.

And the freedom of domicile selection is particularly valuable. The captive is typically established in a specific jurisdiction, known as the "domicile," which may offer regulatory advantages, tax benefits, and a stable legal environment for its operation.

Finally, to mitigate the potential exposure to large losses, captives often purchase reinsurance from traditional insurers or reinsurers, which provides the owners the freedom and flexibility of self-insurance with the security of a back-up option.

Conclusion:

Captives are not an endeavor to enter into lightly. Creating and operating a captive insurance company requires financial resources, expertise in insurance management, and an understanding of regulatory compliance in the chosen domicile. But captives are a unique tool for the right candidates. And, as mentioned above, they are not just for large organizations. Smaller entities, particularly in the healthcare market, who face high risk and pay high premiums may want to consider exploring this option. And those that do are often successful.

However, it is imperative that those considering captive formation engage counsel or insurance professionals familiar with this market and the governing laws to ensure proper set up and compliance. These professionals are also important for positioning the entity to maximize the benefits outlined above.

The Takeaway:

The takeaway here is that captives present an opportunity to have more control over costs and risk management, but they are a unique aspect of insurance law. And those interested should familiarize themselves fully with the risks, benefits, and requirements and engage professionals to ensure entering into this endeavor is informed and accurate so as to fully and adequately make the most of the advantages of this mechanism.