A captive is an insurance company created and wholly owned by one or more non-insurance companies to insure the risks of its owner (or owners). Captives are essentially a form of self-insurance whereby the insurer is owned wholly by the insured. They are typically established to meet the risk management needs of the owners or members. Captives are formed to cover a wide range of risks; practically every risk underwritten by a commercial insurer can be provided by a captive.
Captives can be established to provide coverage where insurance was unavailable or unreasonably priced. The benefits of a Captive include:
- Asset protection from the claims of business and personal creditors;
- Reduction in the amount of insurance premiums presently paid by the operating company;
- Access to the lower cost reinsurance market;
- Insuring risks that would otherwise be uninsurable and the
- Opportunity to accumulate wealth in a tax favoured vehicle.
This alternative form of risk management is becoming a more practical and popular means through which companies can protect themselves financially while having more control over how they are insured.
There are various types of captive structures. The vast majority of captives insure only the risk of its parent (‘pure’ captive).
Captives operate on two main bases;
This is the most prevalent form of captive in Europe. This type of captive underwrite risks through a local insurer, termed a fronting insurer, which is generally a conventional external insurer.
The parent and/or its subsidiaries pay premiums to the fronting company in exchange for cover which is provided on the understanding that a large proportion of the total risk is reinsured to the captive.
One of the primary reasons for operating a reinsurance captive, rather than a direct writing captive, is that in some territories the law requires that certain types of coverage can only be purchased from insurers licensed within that territory
These are captive insurers which underwrite the risks of the parent company, without the use of a fronting insurance company.
The fundamental advantage of this form of captive lies in the fact that the entire underwriting process takes place in house, thus eliminating the expenses of the fronting company.
In addition, the use of a direct writing captive structure facilitates access to the wholesale reinsurance market and thus provides a highly cost effective risk transfer solution to corporate clients.