Captive Insurers

A captive insurer is captive in the sense that it is owned and operated by the insured. There is a point at which it makes economic sense for a company to establish and operate its own insurer as part of the company’s risk management program rather than pay premiums to independent insurers.

Captive insurers may be owned by a single insured, by a trade association, or by a group of affiliated companies. Ownership of a captive by a single insured gives that insured additional comfort that coverage will be available, that reserves will be invested in a manner suitable to the insured, and that success of the captive may result in dividends for the insured. However, the insured will need to balance against those benefits the uncertainty of a tax deduction for premium payments to the insurer (although premiums to reinsurers would remain deductible) and the lack of risk sharing among multiple insureds.

Trade associations may wish to establish a captive insurer. A captive insurer for an association would allow the association to guarantee some form of insurance coverage for association members, and a captive insurer likely would develop special expertise in the insurance needs of association members and in the most efficient way of meeting such needs. For example, a captive insurer established by an association of teams in a sport such as basketball would develop special expertise about the insurance needs of association members that an outside insurer would find difficult to duplicate. As with a captive insurer established by a single company, economic merits of establishing a captive insurer for an association must be evaluated. A major consideration will be the extent to which there is a stable market from sources outside the association for insurance needed by the association members. If not, a captive insurer for the association could be a primary benefit the association could offer its members.

Group captive insurers are established by groups of insureds with common insurance coverage interests. While the companies are not affiliated through an association or otherwise, establishing a common insurance program through a captive insurer is more economically viable than individual insurance programs. Under the Liability Risk Retention Act of 1986, risk retention groups are authorized to provide insurance to members of the group, and purchasing groups are authorized to buy insurance on behalf of members of the group.

Overall, formation of a captive insurer may be seen as a third step in a growing company’s risk management program that progresses from payment of premiums to outside insurers to self-insured retentions and then to formation of a captive insurer. Benefits to the company from owning and operating its own insurer include control over pricing, coverage, and claims administration. Pricing and availability cycles that independent insurers go through may be avoided, and costs of insurance coverage will not be affected by risks of other companies.

Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.