This article was originally published (March 2008) in Director of Finance, Corporate Purchasing, 2008

Your company needs to consider the risks of the business that need to be covered. So, whether independently or via a broker, you pick up insurance cover through the commercial market because, although it might be a long winded and maybe costly exercise there are no other alternatives, right? Wrong. There are other ways and one of those is captive insurance. It can offer several advantages, including reduced costs and unlike the past, these are accessible not just to large public or international companies but now also small to medium sized enterprises (SMEs).

There is a growing awareness of captive insurance and its potential benefits, as evidenced by both global statistics and those from jurisdictions such as Guernsey, which is a recognised innovator in the field, hosts more captive insurance companies than anywhere else in Europe and is home to the full range of providers of captive management services. So, increasingly, there is a divide between companies who are assessing the merits of captive insurance and where appropriate, picking up the benefits and those who have not even thought about that option and as such are following a risk management strategy that has not considered all the options and as a result is potentially more costly.

Pure Captives

Captive insurance is effectively self-insurance. It is actually a relatively mature concept but because it is not the 'convention', can take various forms and has traditionally been viewed as the preserve of large organisations, it is perhaps less well understood than other ideas of a similar heritage.

Captive insurance, in its purest form, is where a company (the captive) is set up by its owners primarily to insure the risks of its parent (and/or subsidiaries). This can offer several advantages in comparison with insuring through the commercial market, including a greater range of cover, proportional premiums, financial savings and risk management awareness:

Greater Range of Cover

  • The insuring of unusual or catastrophic risks or multiple small risks

Proportional Premiums

  • Premiums that relate to the insured's previous claims record

Financial Savings

  • Avoid subsidising large overheads and profit margins of commercial underwriters
  • Direct access to the wholesale reinsurance market
  • Benefit from the investment return on retained premiums
  • Retention within the group of the excess of net premiums over claims
  • Taxation efficiencies – the payment of insurance premium is deductible in arriving at profits and receipt is at the group's offshore captive

Risk Management Awareness

  • Improved risk management and understanding of the cost of risk

Many large public and international organisations have assessed how these potential advantages apply to their operations in practice and subsequently abandoned the commercial market in favour of establishing a captive.

However, SMEs have found that the benefits of a captive, given the likely volume of business, can be outweighed by the start-up and on-going costs. Participating in a 'rent-a-captive' scheme offers the advantage of sharing those expenses but firms are cautious about doing so in a conventional company, where all of the assets and liabilities are linked and thereby risk that the failure of one insurance programme will lead to the loss of assets relating to another.

And so the answer is.....

Cell Companies

In 1997, Guernsey pioneered the Protected Cell Company (PCC) – a company made up of a core and individual cells, where the legal segregation ensures that no claim against one cell will be covered by the assets within another. Several jurisdictions, including Guernsey, have also now introduced the Incorporated Cell Company (ICC). An ICC, like a PCC, has cells but they are separately incorporated and distinct legal entities, offering an added layer of protection in the separation of assets and liabilities.

The use of a third-party cell company rather than a full-blown captive has distinct benefits which for SMEs, in particular, makes captive insurance far more viable:

Lower Operating Costs

  • Savings from reduced reporting requirements and shared costs

Less Management Time

  • Reduction in the amount of executive time required by the cell owner, primarily because attendance is not required at quarterly PCC Board meetings

Quicker And Cheaper To Set Up And Exit

  • Setting up and closing down a PCC cell does not require the same legal processes required to incorporate or wind up a company

No Minimum Capital

  • Need to cover the minimum margin of solvency and the risk gap but this may be less than the £100,000 minimum required for a separate captive

Less Tax

  • Using a PCC can avoid being subject to Controlled Foreign Company legislation

Guernsey is already engaging with the UK SME community on this issue through a series of initiatives with the British Insurance Brokers Association (BIBA).

Captive insurance – even with the option of using a third party cell company – may still not prove to be the most attractive option for some firms, (for example those smaller businesses where the level of premium is less than £250,000). However, such are the potential benefits of captive insurance for all sizes of company that an insured's risk management strategy could be considered somewhat deficient in scope and responsibility if it does not involve the use (or at least consideration) of some form of captive insurance.1

Growing Recognition

There is growing recognition of this, including from SMEs and their brokers, as evidenced by the continuing rise across the globe in the number of captive, PCC/ICC and cell formations2. Guernsey, for example, while a mature jurisdiction in terms of captive insurance, saw the number of captive entities rise again in 2006 to reach 624 at the end of the year. Increasingly therefore those companies who are unable to explain and analyse the full range of options, including captive insurance, will find themselves at a disadvantage.

The Guernsey Option

Many jurisdictions around the world offer captive insurance, including the use of the cell company. However, it is Guernsey which can boast the richest heritage in these areas: since the first captive was established in Guernsey in 1922, the Island has grown to become the leading jurisdiction in Europe for captive insurance and number four in the world in terms of premiums written; and in 1997 Guernsey pioneered the cell company concept which has gone on to be such a success during the decade – at the end of that year there were six PCCs and 14 cells domiciled in the Island but by the end of 2006 this had risen to 68 PCCs and 243 cells and included the formation of the Island's first insurance-writing ICC.

This experience means Guernsey has accumulated a great wealth of related expertise. The Island now plays host to 27 captive managers, ranging from small boutique operations to large international players and independent captive managers through to broker-tied managers, where there is extensive experience, expertise and professionalism.

They manage captives with parents from around the world but it is from the UK where the vast majority of business is derived. Approximately, 40% of the FTSE 100 companies have captives in Guernsey and a report published in March 2007 by Marsh showed that 50% of the captives established by UK companies are based in Guernsey. Guernsey is a natural choice for UK companies because the Island is a British Crown Dependency with legislative and fiscal independence from the UK and outside the EU; English speaking; uses the British pound; and is located within easy reach and with regular links to both the UK and also continental Europe.

The Way Ahead

I leave you with the words of Andrew Tunnicliffe, Group Managing Director, Business Development, Aon Global Risk Consulting: "there is still a long way to go before companies are truly managing risk are missing out on significant cost savings by not using captives as part of your risk management programme."3

Is it time to re-examine your policy to see if the captive insurance option delivers a saving?


1 The report, Global 1500: A Captive Insight 2007, published in summer 2007 by Aon Global Risk Consulting notes that insurance buyers within the world's largest companies are failing to achieve a better quality of cover as well as cost savings of typically 10-15%, through economies of scale, efficient use of capital, leverage and more efficient use of senior management time.

2 The Journal, the magazine of the Chartered Insurance Institute, reports in the October, 2007, article 'Capturing Interest' that there are some 5,000 captives globally, writing more than $20bn in premium and with a capital and surplus at more than $50bn. Andrew Tunnicliffe, Group Managing Director, Business Development, Aon Global Risk Consulting says that the report, Global 1500: A Captive Insight 2007, published in summer 2007 by his firm, "shows that growth in the captive market is not slowing down."

3 Andrew Tunnicliffe, Group Managing Director, Business Development, Aon Global Risk Consulting, commenting on the report, Global 1500: A Captive Insight 2007, published in summer 2007 by his firm.

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