We're seeing more organizations considering captives in light of hardening markets for some risks. What key decisions clarify whether captives are appropriate for your risk management programme?
We're seeing more organizations consider captives as part of their risk management programmes driven by a variety of factors; providing coverage for risks markets don't want to cover or are too expensive to obtain, helping better manage risks, reducing overall insurance costs and increasing retention levels to access to markets that would be otherwise inaccessible.
But captive solutions can appear complex and require careful consideration of their likely efficiency and ongoing costs and governance. So, in this insight we suggest five questions that clarify the path to your organization using a captive, illuminating some of the key considerations and opportunities available.
Q1: Do you want to retain risk?
There are critical decisions to make when structuring a cost-effective risk financing program: to retain risk or not, how much to retain, to pre-fund the cost of risk and finally, deciding the right funding vehicle for the organization.
A captive is one option. These limited purpose, licensed insurance companies' main purpose is to insure or reinsure the risks of the captive's owner(s). Captives are risk assumption vehicles which are insurance or reinsurance companies specifically established to insure or reinsure the risks of the parent company or associated third parties.
Captives act as a facilitating mechanism for organizations that want to trade more directly in the risk transfer market and take a position on their own risk. Typically, the 'parent' pays premiums to the 'front' (or fronting carrier), the front issues the policy and deals with claims, reinsuring the program back to the captive with the element that the parent wishes to retain.
A common captive structure typically sees a captive manager – an organization that can take responsibility for the day-to-day operation of the captive – take care of functions like accounting, treasury, administration, regulatory interaction, governance and compliance and underwriting for and on behalf of the captive owner.
You can use a captive for a range of purposes:
- As a strategic risk management tool/enabler to support moves to additional self-insurance
- To reduce or stabilize cost, recapture investment income or accelerate/manage cash flow
- To bring discipline and attention to risk management and intensify loss prevention moves
- To create segregated, protected pool of monies to pay for retained losses.
Q2: What type of captive will meet your needs?
There are a range of different captive structures:
- Single parent captive, sometimes known as a ' pure' captive – this structure involves you forming a wholly owned (re)insurance company largely for the (re)insurance of your organization's risks
- Group captive – as the name suggests, this is a wholly owned (re)insurance company with multiple owners or sponsors, formed to (re)insure the risks of its shareholders with member companies from the same or different sector
- Cell captives – this is where parent or sponsor facilitates a captive featuring 'cells' used by either related or unrelated parties and where cells effectively function as independent captives.
- Risk retention group and micro captive – both of these options are only applicable in the U.S.
Q3: What costs can you expect with a captive?
The captive owner will pay both fronting fees and claims. Further costs arise around establishing and operating a captive, and the financial commitment required. The key components of this can include premiums and insurance premium taxes, excess insurance/reinsurance, claims administration and captive general and administrative costs.
You can also expect costs around ongoing management of your captive, including actuarial and audit costs and legal, tax and domicile fees.
In terms of capital, this will depend on the minimum required by jurisdictions and can take the form of cash or a line of credit (LOC) or other forms.
A captive feasibility study will help provide certainty on the projected costs and capital requirements. The study will also clarify further key decisions, including the most appropriate domicile, which is the state, territory, or country that will license your captive and has regulatory oversight.
Q4: Which domicile for your captive?
There are around 71 captive domiciles globally, including European, U.S. and Canada, off-shore and Asia-Pacific options, with each location having different regulatory and fiscal advantages.
There are a number of factors on the most appropriate domicile for your captive:
- The quality of the local infrastructure and expertise
- Capitalization requirements
- Accessibility and stability of regulators
- Ease of conducting business.
A captive feasibility study can provide answers on the most appropriate and efficient domicile for your captive.
Q5: What are the ideal conditions that suggest a captive is appropriate?
We suggest there are number of indications that suggest ideal conditions for a captive to be an efficient and effective part of your risk and insurance program, including:
- A gap in coverage and lack of capacity in the market to bridge that gap
- Coverage lines in consideration that include property and liability (general, public, products, professional indemnity) risks and employee-related risks such as employer's liability/workers' compensation, personal accident and employee benefits
- Your organization having established robust risk management and risk governance practices
- A desire to fund risk, build up retention limits, and access wider markets
- A willingness amongst business leaders to consider tailormade risk solutions and creative and innovate risk techniques
- A recognition the business needs to insure uninsurable risk.
You can get more insight in WTW's 2022 expert seminar on 'Captives 101' by filling in the form at the top of this page.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
