Definition
A captive insurance company is an insurance entity established and wholly owned by one or more non-insurance companies to insure the risks of its owners. Essentially, it is a form of self-insurance where the insurance company is created, owned, and controlled by its insureds. This structure provides the parent company with tailored risk management solutions and potentially favorable cost benefits.
Key Features:
- Ownership: Owned by the insured party or parties.
- Purpose: Provides insurance for the risks of the parent company.
- Regulation: Subject to insurance regulations of the jurisdiction in which it is domiciled.
- Advantages: Customized coverage, potential for cost savings, access to reinsurance markets, and potential tax benefits.
Examples
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Single-Parent Captive (Pure Captive): A multinational corporation establishes a captive insurance company to cover its global risk exposures, including property damage, business interruption, and employee benefits.
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Group Captive: Several small manufacturing companies in the same industry form a group captive to pool their insurance risks. This helps them achieve better risk distribution, lower premiums, and access to a tailored risk management program.
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Agency Captive: An insurance agency forms a captive insurance company to provide coverage for the difficult-to-insure risks of its clients, thereby offering more competitive and customized insurance solutions.
Frequently Asked Questions
Q: What are the main reasons companies form captive insurance companies? A: Companies form captive insurance companies to gain better control over their insurance costs, tailor coverage to their specific needs, potentially reduce premiums, and access reinsurance markets. Captives can also provide tax benefits and improve cash flow management.
Q: How is a captive insurance company regulated? A: Captive insurance companies are regulated by the insurance authorities in the jurisdiction where they are domiciled. Regulations can vary significantly between jurisdictions, influencing factors like capital requirements and reporting standards.
Q: Can captive insurance companies insure risks other than those of the parent company? A: While captives primarily insure the risks of their parent company or companies, they can sometimes provide coverage to unrelated third parties, depending on regulatory allowances and the specific structure of the captive.
Q: What is the difference between a pure captive and a group captive? A: A pure captive is owned by a single parent company and insures only the risks of that company. In contrast, a group captive is owned by multiple companies and insures the risks of all its member companies, often in the same industry.
Q: Are there any tax implications for captive insurance companies? A: Yes, captive insurance companies can offer tax benefits, such as deductions for premium payments. However, they must comply with regulations to ensure they qualify as insurance companies under tax laws. The specifics depend on the tax jurisdiction.
Related Terms
- Risk Management: The process of identifying, assessing, and controlling threats to an organization’s capital and earnings, including the use of insurance and captive insurance companies.
- Reinsurance: Insurance purchased by an insurance company from another insurer to reduce the risk of large losses. Captive insurance companies often use reinsurance to manage their risk exposure.
- Self-Insurance: A strategy where a company sets aside funds to cover potential losses instead of buying insurance. Captive insurance is a formalized form of self-insurance.
- Underwriting: The process by which an insurer evaluates the risk of insuring an applicant and determines the terms and pricing of the coverage.
- Domicile: The country or state in which a captive insurance company is legally based and regulated. The domicile’s regulatory environment can impact the captive’s operations and benefits.
Online References
Suggested Books for Further Studies
- “Captive Insurance Companies: Establishment, Operation, and Management” by Kathryn A. Westover
- “Handbook of Captive Insurance Companies” by Donald S. Malecki
- “The ART of Risk Management: Alternative Risk Transfer, Capital Structure, and the Convergence of Insurance and Capital Markets” by Christopher L. Culp
Accounting Basics: Captive Insurance Company Fundamentals Quiz
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