What Is a Captive Insurance Company?
A captive insurance company is a wholly-owned subsidiary insurer formed to provide risk mitigation services for its parent company or related entities. Companies form “captives” for various reasons, such as when:
- The parent company cannot find a suitable outside firm to insureit against particular business risks
- The premiums paid to the captive insurer create tax savings
- The insurance provided is more affordable
- It offers better (or more affordable) coverage for the parent company’s specific risks
Key Takeaways
- A captive insurance company is a wholly-owned subsidiary that provides risk mitigation services for its parent company or related entities.
- The potential benefits of a captive insurance company include lower insurance costs, tax advantages, underwriting profits, and greater control over coverage.
- Captive insurance companies can be helpful when the commercial insurance market is unable or unwilling to provide coverage for certain risks.
- Drawbacks include overhead expenses, compliance issues, and the potential to be underinsured.
- Most Fortune 500 companies today have captive insurance companies.
Understanding a Captive Insurance Company
Acaptive insurance company is a form of corporate self-insurance. While there are financial benefits to creating a separate entity to provide insurance services, parent companies must consider the associated administrative and overhead costs, such as additional personnel and startup costs. There are also complex compliance issues to consider. As a result, corporations that form captive insurance companies generally rely on traditional insurers to insure against some risks. They can also use reinsurance companies to distribute some of the risk that would otherwise be assumed by the parent company.
Captive insurance companies are often formed to supplement commercial insurance, allowing the parent company to keep the money it would otherwise spend on additional insurance premiums.
A captive insurance company should not be confused with a captive insurance agent, who is an insurance agent who only works for one insurance company and is restricted from selling competitors’ products.
Tax Issues of Captive Insurance Companies
The tax concept of a captive insurance company is relatively simple. The parent company pays insurance premiums to its captive insurance company and seeks to deduct these premiums in its home country, often a high-tax jurisdiction. Today, several U.S. states allow the formation of captivecompanies. Protection from tax assessment is asought-after benefit for the parent company.
Whetherthe parent company realizes a tax break from creating a captive insurance company dependson the classification of insurance that the company handles. In the United States, the Internal Revenue Service (IRS) requires risk distribution and risk shifting to be present for a transaction to fall into the category of insurance. The IRS has publicly declared it would take action against captive insurance companies suspected of abusive tax evasion.
Some risks could result in substantial expenses for the captive insurance company, potentially leading to bankruptcy. Single events are less likely to bankrupt a large private insurer because of the diversified pool of risk that they hold.
Pros and Cons of Captive Insurance
Captives can be an attractive option for companies looking for ways to manage and distribute risk, but there are advantages and disadvantages.
Pros and Cons of Captives
Pros
Potential cost savings
Tax advantages
Greater control over coverage and claims
See Also6 Cs of NursingUnderwriting profits
Cons
Company’s capital is at risk
Potential to be underinsured
Overhead expenses and startup costs
Potential compliance issues
Examples of Captive Insurance Companies
A well-known captive insurance company made headlines in the wake of the 2010 British Petroleum oil spill in the Gulf of Mexico. At that time, reports circulated that BP was self-insured by Guernsey, U.K.-based captive insurance company Jupiter Insurance, and that BP could receive as much as $700 million in coverage from losses. British Petroleum is not alone in this practice—indeed, most Fortune 500 companies today have captive insurance subsidiaries.
In a more recent example, the state of Tennessee launched its own captive insurance company in 2022 to cover state-owned buildings and contents, including Tennessee’s public college campuses, as well as general liability. The captive insures property valued at $31.4 billion as of July 2022.
According to a press release, the state’s Division of Claims and Risk expects the captive to help insure unique and difficult risks and reduce overall insurance costs. “The use of a captive will also allow the State to better evaluate and control the risks of Tennessee state government,” the release stated.
There are numerous types of capitive insurance companies, including pure captives (which only cover the parent company and affiliates) and group captives (insuring several members of a specific group). Micro captives are smaller entites with annual written premiums up to $1.2 million.
FAQs
Who Owns a Captive Insurance Company?
A captive insurance company (or captive) is formed, owned, and controlled by the parent company that it insures. The National Association of Insurance Commissioners (NAIC) estimates that about 90% of Fortune 500 companies today have captive subsidiaries.
Is Captive Insurance a Good Idea?
Captive insurance is essentially a type of self-insurance that allows a company to meet its unique risk management needs. Captives can be a good idea because they might offer lower costs, significant tax advantages, underwriting profits, and greater control over coverage and claims decisions. They are also helpful if the commercial insurance market can’t provide coverage for certain risks. However, there are disadvantages to consider, including the potential to be underinsured or have a poorly drafted policy.
Which Types of Coverage Do Captives Provide?
Captives aren’t intended to protect against all risks. Companies that use them generally rely on conventional commercial insurers to protect against certain risks. While captives permit companies to manage risks that traditional insurers don’t (or won’t) cover, captive insurance is often used for standard casualty lines like general liability, product liability, professional liability, and workers’ compensation.
How Do Captives Differ from Mutual Insurance Companies?
The primary difference is that captives are formed and owned by a parent company to insure only its risks and those of its affiliates, while a mutual insurance company sells protection products to policyholders amongst the general public. A captive is owned by its parent, while a mutual is owned by its policyholders.
The Bottom Line
Insurance is a significant expense for large companies. Captive insurance companies offer a way for companies to control costs, reap tax benefits, and cover risks that commercial insurance companies might be unable or unwilling to insure. While setting up a captive can be challenging, third-party captive professionals can help companies navigate the process and avoid costly mistakes.
