Why Form a Captive?

In addition to all the usual benefits associated with self-insurance, establishing a separate legal entity to act as a captive insurer has a number of unique advantages that do not exist with traditional self-insurance. For example a new profit centre is established which can eventually expand its expertise, either to other classes of insurance or by offering cover to subsidiary companies that are not initially provided for.

In addition expertise can be sold to other companies that may wish to take advantage of any unique underwriting skills that have been developed. Also, another major advantage is that access to the reinsurance markets is made possible and risk transfer solutions that protect the captive's capital base can be tailor made according to each captive's requirements.

A Summary of the Potential Advantages of Setting up a Captive

Advantages of setting up a captive can include the following:

1. A Separate Profit Center is established. The company retains underwriting Profits and Investment Income.
2. Tailor-made Coverage can be made available even if commercial insurers are unwilling to provide it. In today's climate terrorism coverage would be a good example but any peril, exclusion or level of cover not normally provided by the regular insurance market has the potential to be covered through a captive.
3. Incentive for Greater Loss Control is established which can result in a safer workplace with reduced claims and greater retained underwriting profits.
4. Claims Settlement is quicker as the captive owner is paying its own claims. This in turn can assist the cash flow of a company.
5. Established Methods of forming a captive already exist and service providers are readily accessible to assist in the formation and running of a captive. Legislation exists in many domiciles to allow captives to be established with relative ease and minimal cost.
6. Reinsurance markets anywhere in the world can be approached and solutions to protect a captive's capital base can be arranged without state and federal influence over coverage issues.

A Summary of the Potential Disadvantages of Setting up a Captive

Any Potential Disadvantages of Captives of a Company can be reduced with proper planning but it is important for any company contemplating a captive arrangement to be sure that the captive approach is suitable for its purposes The Disadvantages if proper planning is not undertaken include the following:

1. A Long-Term Commitment is needed due to the amount of managerial time and expense that is required. For smaller companies the formation of a captive may be uneconomic and prove an expensive diversion of managerial time that could otherwise be directed towards the company's main operations.
2. Potential Losses may cause an adverse cash flow if proper underwriting controls and reinsurance arrangements are not put in place.
3. State Legislation often does not allow captives to offer insurance coverage directly to companies and therefore a fronting company, sometimes known as an issuing carrier, is required which can add to the cost. An exception to this rule are Risk Retention Groups which are permissible under Federal legislation however these organisations still need to licensed by each individual state.