Captive insurance - is it for me?

Guest author: Richard Packman

Chief Executive Officer, Vantage Limited

It is well known that the conventional insurance market frequently fails to meet the needs of the buyer, with criticism usually falling into one, or more, of three categories – price, cover, and service.

What if you could have more control of these elements? What if you could form your own insurance company for your own purposes? Well, the captive insurance market can allow this.

People forming their own insurance companies to insure the risks of the owners dates back to the dawn of the modern insurance industry. From the 1920s, more and more larger corporations established their own insurance companies, but the term “captive” (as we know it today) was first used in the 1950s. A US industrial company in Ohio had a series of mining operations and its management referred to the mines whose output was put solely to the corporation’s use as captive mines. When they incorporated their own insurance subsidiaries, they were referred to as captive insurance companies because they wrote insurance exclusively for the captive mines.

Today the captive insurance industry is still growing, with thousands of captives established in more than 50 jurisdictions around the world. The rate of captives traditionally develops in response to “hard” insurance markets (where premiums increase), although they are to be regarded as part of a longer term risk management strategy, rather than short term cost saving vehicles.

Why do it?

The conventional insurance market can be a cumbersome and inflexible risk management tool.

Creating a captive insurance vehicle provides a bona fide self-insurance mechanism, which can offer a superior alternative to the traditional insurance market for all, or sometimes just part, of an insurance programme. Advantages fall broadly into two categories:

• the opportunity to retain underwriting profit derived from better than average loss records or niche portfolios of insurance business where the traditional market offers little or poor value; and/or
• cost effective risk transfer where the traditional market is applying high rates, restricted cover, increased deductibles or where there is limited capacity.

Captives can offer a degree of insulation from the unpredictable swings of the insurance market cycle, and additional benefits such as direct access to the reinsurance market, positive cash flow, capital leverage, investment income and bespoke cover all contribute to the rationale.

How does it work?

In short, a captive is a specific insurance company established to insure specific risks. In most cases a captive insurer’s owner and its customer(s) - the insured(s) - are one and the same, which results in captives being different from commercial insurance companies.

A captive is a registered and authorised insurance company established to write all or part of the risks of a company, its affiliates, or for the members of a group. Traditionally they have been subsidiary companies of their parent (whose risks they underwrite) however there are now numerous additional uses for such vehicles - including the writing of third-party risks. Commonly located in an offshore domicile, the captive will be licensed by the local regulator to operate either as an insurance or reinsurance company.

Invariably the premium paid into the captive will not be sufficient to cover the overall exposure insured within; for example, a £1million premium spend for a portfolio of 50 properties valued at £10million each. The captive will therefore purchase reinsurance protection to cover this additional financial risk. Reinsurance increases the captive’s underwriting capacity and enables it to stabilise its underwriting results. Pound for pound, reinsurance is cheaper to buy than primary insurance as it is effectively buying from the wholesale market, and reinsurers do not have the front-line overheads of insurance companies.

Who is it for ?

Traditionally captives have been used by corporations for their commercial insurance risks (PLCs, private companies, the public sector, and trade associations) and there is still growth in this area, but more recently interest is being received from private clients. High net worth individuals and family offices with significant premium spend are realising the benefits of a self-insurance arrangement. They may have substantial property assets, art collections, yachts or even a garage full of classic cars – all of which will require insurance protection. In addition, a captive may also provide estate planning benefits as a HNW individual or privately owned business can structure their captive for it to be owned by a trust. In time, the underwriting profit generated from the captive can be transferred to the trust beneficiaries.

In summary, captives offer a wide range of opportunities for a wide range of clients and their growth will continue as more realise the benefits that they can provide.

Correct as of May 2017.