The definition of the term, “Captive Insurance Company” has evolved over the past 60 years. Initially the term meant an insurance company that was wholly-owned by a non-insurance company which provided insurance for only the owner. We now call this arrangement a “Pure Captive.”
The term now refers to any closely held insurance company whose insurance business is supplied by and controlled by the owners, and in which the owner-insureds are the principal beneficiaries. The owner-insureds usually have a direct involvement and influence over the company’s major operations (underwriting, claims, investments, etc…), but this is not always the case.
What about Rent-a-Captives? Where do they fit?
When a business (or group of businesses), does not have or want to commit the necessary capital to start a captive the business may contract with an existing captive and enter into a captive-like arrangement.
There are two basic rent-a-captive strategies; Preferred Stock and Participation Agreement.
The Preferred Stock strategy requires the captive renter to purchase a new class of preferred shares in the existing captive. The preferred shares provide for the profits of new insurance program to inure to the benefit of the captive renter in the form of preferred stock dividends.
Alternatively, the captive renter can execute a Participation Agreement which provides for the same economic result. In either case, the captive renter purchases insurance from the captive and pays premiums to the captive.
The captive renter is able to realize all of the benefits of a captive without bearing the expense of creating a new captive. The captive renter will bear a rental fee in addition to the normal operational costs of a captive.
How large does my organization need to be to justify having a captive?
There is no particular size requirement. Many captives collect less than $1 Million in annual premium. The key is having enough exposure to achieve predictability for losses.
Where should my captive be domiciled?
Like so many questions, the answer to this one is, “It depends.” If one or two domiciles were the best for everyone there would not be more than 35 domestic and more than 50 international (i.e. “offshore”) domiciles.
Will I be able to avoid Federal Income Taxes by choosing an offshore domicile?
Probably not. At one time offshore companies could legitimately avoid or defer Federal Income Taxes. Over the years the IRS has closed the loopholes that made this possible. Insurance accounting rules still result in the deferral of some taxable events, but not all. Captives should be formed primarily to address legitimate risk financing issues, not to avoid taxes.
Frequently asked questions
Are there different types of Captives?
Captives can be categorized in a number of ways, but it is most helpful to divide them first by ownership.
Single Owner Captives – There are three subtypes; “Pure” and “Economic Family” and “Agency.”
A Pure captive provides coverage only for the captive’s owner.
An Economic Family captive provides coverage only for “brother/sister” subsidiaries of the parent company.
Historically, Agency captives are owned by insurance agencies and provide coverage to clients of the agency. Recently another form of Agency captive has emerged whereby the captive is owned by an interested party and provides coverage to entities that are selected by the interested party. An example of this hybrid would be a franchisor that sets up a captive to provide insurance to its franchisees.
Multiple Owner Captives – Three sub types; Group Captive, Association Captive, and Risk Retention Groups.
Group Captives are formed by multiple organizations that cannot legally or feasibility self-insure themselves on a stand-alone basis. Group captives can be homogeneous or heterogeneous.
Association Captives are usually categorized with group captives despite the fact that there is only one entity that owns the captive. Many people consider them to be a form of group captive because most associations are owned by multiple entities.
Risk Retention Groups are Group Captives that are licensed under the provisions of the Risk Retention Act of 1986. RRGs must be owned by the policyholders and can only provide 3rd Party Liability Insurance. Unlike other captives, an RRG is allowed to operate in any state so long as they have met the registration requirements of the Risk Retention Act.