What Types of Captive are there?
There are a variety of types of captive apart from the pure or stand-alone vehicle, which only insures its parent’s risks.
Captives can be established by commercial organisations that wish to insure their customers’ risks. For example, high street domestic appliance retailers in the UK have in Gibraltar a captive which underwrites extended warranty insurance for products sold to their customers.The combination of an established customer base, and the low costs of running a captive make this type of operation attractive.
Another variation is group or association captives, where organisations with similar risks in a particular trade combine to form a jointly owned insurer to insure those risks. A good example of this is the many medical malpractice captives in the USA, where groups of doctors combine to insure professional indemnity risks, an expensive insurance in the traditional market in litigation-conscious USA.
Becoming more prevalent in today’s alternative risk financing world are rent-a-captives and cell captives, and in recent years Protected Cell Companies. Their principle is that organisations wishing to benefit from a captive structure, rather than establishing their own vehicle, rent or buy shares in an existing insurer, which has investment and reinsurance facilities already set up. This can be a lower cost option to the traditional stand-alone captive route, and can be tax-efficient. More about PCCs in Gibraltar can be found here.
What do Captives do?
Most captives start in a relatively small way, selecting certain areas of the parent’s risks to insure, whilst other elements are placed in the traditional insurance or reinsurance markets. The captive’s capacity depends on its capitalisation, and parents are usually conservative when it comes to retention of risk within the captive. The types of risk usually insured “in-house” will be those of a predictable nature, usually high-frequency low-severity risks (such as small liability claims), leaving catastrophic risks, by their nature more volatile and harder to predict, to traditional markets. In this way the captive’s capital (which at the end of the day is group capital) is not overly exposed to uncertain losses.
In all captive insurance structures, the principle motivating factor is a reduction in costs to the parent, or production of additional profit (as in the case of customer-insuring captives). The main area where this is achieved is usually in the expense ratio: captives do not have to advertise or maintain substantial overhead costs of sales staff, branch networks, corporate image and so on. A captive is often managed by a third party manager for a fee, rather than maintaining its own personnel, which reduces not only costs but commitment of management time from the parent. Captives are also often established in offshore domiciles, where statutory regulation is more straightforward than in the major countries.