Captive Insurer is an insurance company that is wholly owned and controlled by its insured’s. Its primary purpose is to insure the risks of its owners and its insured’s benefit from the captive insurer’s underwriting profits.
These points do not clearly distinguish the captive insurer from a mutual insurance company. A mutual insurance company is owned and controlled by its policyholders. But no one who is a mutual insurance company’s policyholder exercises control of the company. The policyholder may be asked to vote on matters requiring policyholder action. But this usually means that the policyholder will be presented with a proxy and advised by the board that runs the company as to how to exercise its vote. As soon as the insurance ceases, so does the policyholder’s ownership status. The policyholder has not invested any assets in the insurance company and does not actively participate in running it.
Captive insurance is utilized by insured’s that choose to
- Put their own capital at risk by creating their own insurance company.
- Working outside of the commercial insurance marketplace.
- To achieve their risk financing objectives.
Any insured who purchases captive insurance must be willing and able to invest its own resources. The insured in a captive insurance company not only has ownership in and control of the company but also benefits from its profitability.
A policyholder in a mutual insurance company is theoretically entitled to receive dividends if the company makes a profit. In reality, however, mutual insurance companies generally accumulate rather than distribute their surplus.
When the products offered by insurers do not meet an insured’s risk financing needs, the best option might be to form a captive insurer. The main reasons why organizations wish to better control their risk management programs are excessive pricing, limited capacity, coverage that is unavailable in the “traditional” insurance market, or the desire for a more cost efficient risk financing mechanism. Other reasons for utilizing captive insurance include
- Broader coverage,
- Stability in pricing and availability,
- Improved cash flow, and
- Increased control over the program.
Types of Captive Insurance
- Pure captives: captive insurers that are 100 percent owned, directly or indirectly, by their insured’s.
- Sponsored captives: captives owned and controlled by parties unrelated to the insured.
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Pure Captives
The term pure captive is generally used to describe captives insuring only the risks of their owner or owners. Single-parent captives have only one owner. Group captives have multiple owners.
A group captive is formed by a group of individuals or entities that come together to jointly own a captive insurance company. Industrial insured group-owned captives typically insure only insureds in the same industry group, or with homogeneous risk, which creates group buying power and other risk management efficiencies.
Another kind of group-owned captive allows a group of insureds from entirely different industry groups to own a captive jointly. This type of heterogeneous group captive may be a reinsurance pool, formed to create underwriting capacity through the pooling of risk. A reinsurance pool does not provide direct insurance. It reinsures either the captives of its owners or the admitted insurers that issue policies to the pool’s owners. The group captive or pool may also provide other risk management services for the group.
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Sponsored Captive Insurers
Sponsored captive insurers, sometimes referred to as non-owned or nonaffiliated captives, have many of the same elements as a pure captive insurer. The insureds are required to put their capital at risk, risks are financed outside of the commercial regulatory environment, and the purpose is to achieve the risk financing objectives of the captive’s insureds. However, a sponsored captive is not formed by its insureds—known as participants, and a sponsored captive does not necessarily pool its insured’s risks.
A sponsored captive may be set up by an insurance industry-related entity to be used by its clients, or there may be no previous connection between the sponsor and the participants. The sponsor contributes the captive’s statutory capital (sometimes called core capital). Many sponsored captives do not require insureds to pay in capital, but simply to pay an access fee. These are sometimes referred to as rental captives.
A sponsored captive does not necessarily pool the risks of its insureds. It may keep a separate underwriting account for each insured participant. In some domiciles, these accounts are legally separated or protected, and the term cell captive is used, meaning that the assets in one participant’s account may not be used to pay liabilities in another unless the respective participants have entered into an agreement to do so.
This is a key difference between a pure group captive and a sponsored captive. The sponsored captive can be structured to maintain legally separate underwriting accounts, whereas an insured that is a member or owner in a pure group captive shares risk with the other captive insureds.
Insureds who are shareholders or members of an industrial insured group captive have to contribute capital to access the captive insurance program, and their capital is at risk based on the performance of the group as a whole. In a sponsored (rented) segregated cell captive, each participant’s risk capital is typically only exposed to the risk of its own underwriting performance.
If required under domiciliary law, the sponsor’s core capital may be at risk. This would mean that if one insured becomes bankrupt or otherwise defaults on its obligations, producing an insolvent cell or underfunded underwriting account, liabilities of the cell would become liabilities of the sponsor. In domiciles that do not have the legal requirement that the sponsor’s core capital is at risk, the cell participant may be required to sign an agreement that losses paid under policies issued or reinsured by the captive are limited to the assets in the participant’s cell.
Sponsored captives may be used by insureds that are too small to own their own captives. The captive cell program acts like an incubator for these small insureds to begin a captive program. When sufficient surplus has been accumulated, an insured has the option of using those funds to set up its own pure captive insurance company.
A captive insurer may be formed by an association for the benefit of its members. Does this make it a “sponsored captive”? Not exactly! The association captive is “pure,” meaning that it insures only the risks of its owners. The sponsoring association may contribute 100 percent of the required capital, but since the association is owned by its members, its members indirectly own and have voting control over the captive insurance company.
Captive Insurance Plans 