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Captive
Basics
What
is a captive ?
A
captive is an insurance company established by one or more organizations,
and whose main purpose is to insure the risks of those organizations.
There are
different types of captives :
- A single
parent captive which insures related risks only.
- A group
or association captive which is owned by the group or association members
and insures the risks of the group or association only.
- An agency
captive which is owned by an agency or broker which reinsures a portion
of their clients' risks.
- Open market
captives which write unrelated business.
- Segregated
account companies or protected cell companies, which provide legal separation
of assets and liabilities of individual programs.
Why
establish a captive ?
Forming
or participating in a captive can allow you to reap a number of benefits:
- Stable capacity
– a captive can provide coverage for unusual and/or uninsurable
exposures and can also eliminate cyclical pricing and capacity fluctuations
inherent in the conventional market.
- Cost reductions
– pricing in the conventional market includes profits and overhead.
Although establishing a captive does not eliminate these costs, it should
reduce them. And, depending on your loss history, there may be substantial
underwriting profit.
- Cash flow
– a captive will enjoy the benefit of investment income earned
on funds supporting unearned premium and loss reserves, income which
is usually enjoyed by the conventional market.
- Access to
reinsurance – a captive has the ability to access the international
reinsurance market, obtaining reinsurance protection which can be less
expensive than conventional direct and umbrella coverage. In addition,
a captive has the opportunity to reduce costs by combining multiple
lines of risk, and may also earn ceding commission, profit commission
or both.
- Unbundling
of services – a captive will facilitate the unbundling of risk
control and claims handling services from the actual purchase of insurance.
- Risk control
discipline – a captive may instill an improved awareness of risk
control within the parent organization, thus reducing insurance costs
even further.
- Taxation
– the establishment of a captive should always be determined by
its validity as an insurance operation, independent of any tax advantage,
which should be viewed as an incidental, but possibly significant advantage.
Prerequisites
for Success
Many
captives may fail even before they commence operations. To ensure the
success of your captive, the following prerequisites should be in place:
- Management
Commitment – it is crucial that the parent company’s management
is committed to the captive, and understands and appreciates the captive’s
role in the risk management function.
- Risk Control
– there is a strong need for effective risk control techniques,
which should ensure that, over the years, the loss experience remains
far better than the industry average.
- Risk Identification
and Evaluation – well-developed techniques for the identification
and evaluation of risk should be used. In addition, the attitude of
the organization toward retaining risk will be important when a decision
is made on reinsurance and future development.
- Market Factors
– the co-operation of the conventional market is required. A captive
must have the ability to buy adequate and reasonably priced reinsurance.
- Management
Services – it is essential that there are adequate management,
legal and financial services available in the domicile selected for
the captive.
- Group Captive
– for group captives to succeed, there must be a long-term commitment
from the members, adequate capitalization, selective membership standards,
risk sharing, profit allocation and distribution plans, and exit strategies.
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