Captives are wholly owned insurance subsidiaries usually formed offshore to underwrite and carry, generally in part, the risks of their parent or sponsor. They are offshore because the legislation is designed for captives rather than the wider insurance market.
In general the legislation is less onerous and simpler because the captive is insuring its own parent’s risk rather than a third party. Depending upon the requirements (and regulation for compulsory classes) captives can be either insurers or re-insurers.
A common approach is for a captive to underwrite a finite amount of risk in the form of a programme deductible or quota share participation capped in the annual aggregate. This risk can be written directly or is often ceded via a fronting company – usually the lead insurer in the relevant class.
Captives are commonly used by insurance buyers for the following reasons:
- Large insurance spend – advantage can be gained by utilizing a bespoke rating approach, depending on the performance of the business, as opposed to the insurance markets view of the performance of the industry which can ignore positive individual features. Also for large premium spend captives can provide expense ratios significantly lower that traditional insurance companies thereby making premiums work harder.
- Investment income – the opportunity to accrue interest on premiums paid to the captive. This can be significant.
- Control – throughout the insurance cycle captives are in a much better position to provide consistency in price, terms, cover and availability of capacity.
- Capital/Coverage leverage – solvency regulations allow effective use of capital in a captive.