Background on: Captive Insurance

Organizations looking for a flexible risk financing option may use a captive insurer or captive – a special type of insurance company set up by a parent company, trade association, or group of companies to insure the risks of its owner or owners.  Often liability coverage for insuring certain risks with commercial carriers might not be cost effective, customizable, or even available at all. Forming a captive can provide tax benefits. Additionally, captives can provide access to the reinsurance market, using a variety of reinsurance mechanisms to provide coverage. Many offshore captives use a fronting insurer to provide the basic insurance policy.

Captives can come in a variety of structures, customized to meet the needs of its owners/creators. It may be a “single-parent” captive—owned by one entity—or have several owners. They may insure the risks of organizations other than their major owners. Wholly owned captives are companies set up by large corporations to finance or administer their risk financing needs. If such a captive insures only the risks of its parent or subsidiaries it is called a "pure" captive. Companies can also form a joint arrangement of multiple companies, called a group captive. According to an April 2021 white paper published by the Triple-I, A Comprehensive Evaluation of the Member-Owned Group Captive Option, group captives have become an attractive risk management option for a growing number and type of companies.

What are the different types of captives?

The rent-a-captive concept:

Introduced in Bermuda in the 1980s, this concept remains a popular alternative market mechanism. Rent-a-captives serve businesses are unable to capitalize a captive but are willing to assume a portion of their own risk and share in the underwriting profits and investment income.

These captives are generally sponsored by insurers or reinsurers, which essentially "rent out" their capital for a fee. This mechanism allows users to obtain some of the advantages of a captive without having the expense of setting up a single-parent captive and meeting minimum capital and surplus requirements.

The segregated or protected cell captive

An offshoot of rent-a-captives, this concept was introduced in Guernsey in 1997. A protected cell captive offers participants many of the benefits of a group captive but with lower startup costs. The arrangement offers more security to policyholders by isolating assets and liabilities as if each participant were a separate company, called a cell, doing business with the core company.

The history of captives

Captives have been around as a risk financing option for over a century but the term captive insurers was introduced in the 1950s, when fire protection engineer Frederic Weiss formed subsidiaries to cover the risks of an industrial client in Ohio. Since that time, many states and overseas jurisdictions have emerged as popular domiciles for captives.

Captives took on a larger role during the liability crisis of the 1980s, when businesses had trouble obtaining some types of commercial insurance coverage. New mechanisms for transferring risk developed during this time, with captives becoming particularly significant.

Today, there are over 7,000 captives worldwide, according to AM Best Captive Center.

How are captive insurance companies regulated?

A captive insurance firm must be licensed in each state in which it does business or must use a fronting insurer to do business across state lines. Most jurisdictions have established a specific regulatory framework based on the structure and operation of captives. Captives that are owned by publicly held companies also must comply with all the regulatory compliance and governance requirements stipulated by the Sarbanes-Oxley Act, enacted in 2002 to increase the accountability of boards of publicly held companies to their shareholders.

Read about other risk financing options, including self-insurance and risk retention groups.

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