WHAT IS A CAPTIVE?
A captive insurer is a legal entity formed primarily to insure the risks of one corporate parent or a number of similar corporations (e.g., trade associations) thereby contributing to a reduction in its parent’s total cost of risk. Captives are usually domiciled in a specialized location, either offshore or onshore, and sometimes write business unrelated to their parent. Captives are formed for many reasons:
- Lack of commercial market for certain lines of coverage.
- Desire to recapture underwriting profits and investment income that would otherwise be earned by the commercial underwriter.
- As a means to access the reinsurance market.
- In certain circumstances, as a means of diversifying into insurance services.
Captives are used extensively throughout the world by major corporations to cover risks situated both at home and abroad. The largest developments historically have been in the United States, the United Kingdom, and Europe, but recently, considerable interest has been evident in South America, and in the Far East, particularly from Japan and Australia. As the trade barriers throughout the world are lowered and companies become more internationally-oriented, insurance buyers are taking a more global approach to risk financing. Captives can play an integral role in the successful implementation of a global risk financing strategy.
TYPES OF COVERAGE
The most popular lines of coverage written by captives are general/public/third party liability, property, workers’ compensation/employers’ liability, and auto liability.
Non-traditional lines of coverage historically may not have been prevalent in captives, but have been growing in popularity in the last several years. The most common example of non-traditional or core captive coverage is crime insurance/crime deductibles. In addition, a number of companies use their captives to write medical stop loss coverage, placing certain layers of self-insured coverage into the captive, allowing the employer to control and minimize health insurance costs. This coverage will be an exposure to watch as the health insurance industry works to implement the remaining portions of the Affordable Care Act in the US.
Cyber-attacks are becoming more frequent and more damaging. Incidents like the data breach involving a large retailer in 2013, which led to the theft of approximately 40 million credit card numbers and 70 million personal records, have raised the awareness of this risk in the corporate world — and captives are a true reflection of these recent developments. The percentage of companies running cyber liability through their captive is gradually increasing and is a trend expected to continue in the near future for captive arrangements.
Other risks such as supply chain, which is linked to property damage (business interruption and contingent business interruption), have been discussed often within the captive world. Also, voluntary lines of coverage, which can include employee benefit programs such as critical illness, identity theft, and pet insurance, are growing along with purely property and casualty voluntary benefits such as home, auto, and umbrella.
Traditional domiciles, including Bermuda, Vermont, and the Cayman Islands, continue to be the largest captive domiciles. They have developed legislation, maturity, long-time experience, and a captive-friendly institutional infrastructure. However, the dominant position of the traditional captive domiciles is being challenged by upcoming captive domiciles that have become more popular thanks to their efforts to attract captives through flexible but very complete regulations.
In the last few years, some onshore domiciles have implemented captive legislation or resurrected prior captive laws. This phenomenon has led to an increased activity in domiciles, and the emergence of new domiciles is expected in the near future. Globally, there are more than 65 domiciles, but in recent years, there has been a major increase in the number of domiciles. For example, in 2013, Texas and North Carolina, and in 2014, Ohio enacted captive legislation. There are now more than 35 US states, plus the District of Columbia, Puerto Rico, and the US Virgin Islands, with captive laws — and more on the horizon.
Some of the reasons cited by captive owners to move their captive from offshore to onshore are the ability to write employee benefits, the ability to access the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA, but commonly referred to as TRIA) in the US and the potential ease of proximity to the parent company.
There has not been a surge in captive re-domestications in the last two years, nor is it expected as a major trend in the captive arena, even though US onshore domiciles are emerging and gaining new captives and continue to gain expertise. This is contrary to what some had anticipated as a result of the enactment of the US Dodd-Frank Act. In 2013, however, Texas became the first state to enact unauthorized captive insurance premium taxes at a rate of 4.85% payable by an out-of-state captive. Texas is the only state that has implemented such enforcement mechanisms as a result of Dodd-Frank so some movement to Texas is expected.
THE ROAD TO A CAPTIVE
The first phase in establishing a captive includes a consultation to identify the parent’s strategic aims and its tolerance to risk. This consultation is followed by the collection, manipulation, and analysis of loss data and exposures. This phase may culminate in the preparation of a detailed feasibility and/or implementation study to include:
- The captive’s role.
- Appropriate retention levels.
- Its impact on the insurance program’s structure.
- Guidance as to the most appropriate captive domicile.
- Ownership structure.
- Analysis of tax issues.
- Financial projections.
- A cost/benefit analysis.
There are more than 6,300 captive insurance companies worldwide and more are being formed every year. The owners of these captives are from various industries and the lines of coverage provided by these captives are diverse. However, the common thread that links these captives is that their owners have determined that the financial and insurance advantages of owning a captive outweigh the costs involved with forming and running one.
If you are interested in discussing the opportunity for a captve please contact your GDP Advisor 800-473-8697 to setup an appointment to see if your company is a fit.
Published by Author: Gavin Foggon Parker Poe