Captive Insurance – Definition & Detailed Explanation – InsurTech Glossarry

What is Captive Insurance?

Captive insurance is a form of self-insurance where a company creates its own insurance company to provide coverage for its own risks. Instead of purchasing insurance from a traditional insurance company, the company sets up a captive insurance company to underwrite its own risks. Captive insurance is typically used by large corporations with significant risk exposure who want more control over their insurance coverage and costs.

How does Captive Insurance work?

In a captive insurance arrangement, the company forms a separate legal entity, known as a captive insurance company, to provide insurance coverage for its own risks. The captive insurance company operates like a traditional insurance company, collecting premiums from the parent company and paying out claims as needed. The parent company retains the risk and rewards of the insurance coverage provided by the captive.

The parent company can customize the insurance coverage provided by the captive to meet its specific needs and risk profile. Captive insurance can cover a wide range of risks, including property damage, liability, employee benefits, and more. The parent company can also choose to reinsure some of the risks with a traditional insurance company to diversify its risk exposure.

What are the benefits of Captive Insurance?

One of the main benefits of captive insurance is greater control over insurance coverage and costs. By setting up its own insurance company, the parent company can tailor the coverage to its specific needs and risk profile. This can lead to more comprehensive coverage and lower premiums compared to traditional insurance policies.

Captive insurance can also provide tax advantages for the parent company. Captive insurance companies are typically domiciled in jurisdictions with favorable tax laws, allowing the parent company to take advantage of tax deductions and other benefits. Captive insurance can also help the parent company manage its overall risk exposure more effectively by retaining some of the risks and transferring others to the captive.

What types of companies can benefit from Captive Insurance?

Captive insurance is most commonly used by large corporations with significant risk exposure. These companies may have unique risks that are not easily covered by traditional insurance policies, or they may want more control over their insurance coverage and costs. Captive insurance can be particularly beneficial for companies in industries with high liability risks, such as healthcare, construction, and manufacturing.

Small and mid-sized companies can also benefit from captive insurance, especially if they have stable cash flow and a strong risk management program in place. Captive insurance can help these companies reduce their insurance costs, improve coverage, and gain more control over their risk management strategies.

What are the potential risks of Captive Insurance?

While captive insurance can offer many benefits, there are also potential risks to consider. One of the main risks of captive insurance is the financial stability of the captive insurance company. If the captive is not properly capitalized or managed, it may not be able to pay out claims when needed, leading to financial losses for the parent company.

Another risk of captive insurance is regulatory compliance. Captive insurance companies are subject to strict regulatory requirements in the jurisdictions where they are domiciled. Failure to comply with these regulations can result in fines, penalties, or even the loss of the captive’s license to operate.

Additionally, captive insurance may not be suitable for companies with fluctuating cash flow or high-risk profiles. These companies may struggle to fund the captive’s operations and pay claims during periods of financial hardship.

How is Captive Insurance regulated?

Captive insurance companies are regulated by the insurance regulators in the jurisdictions where they are domiciled. These regulators oversee the financial stability, solvency, and compliance of captive insurance companies to ensure they can meet their obligations to policyholders.

Regulatory requirements for captive insurance companies vary by jurisdiction but typically include minimum capital and surplus requirements, risk-based capital standards, and reporting and disclosure requirements. Captive insurance companies may also be subject to regular audits and examinations by regulators to assess their financial health and compliance with regulations.

In addition to regulatory oversight, captive insurance companies may also choose to obtain ratings from independent rating agencies to demonstrate their financial strength and stability to policyholders and reinsurers. Ratings agencies assess the captive’s financial performance, risk management practices, and compliance with regulations to assign a rating that reflects the captive’s creditworthiness.