Monkton
Insurance Services Limited
While there are many definitions of the term captive insurance company, perhaps the most widely used is:
"a closely held insurance company whose insurance business is primarily supplied by and controlled by its owners, and in which the original insureds are principal beneficiaries."
There are many reasons why captives are formed. Among the most common are:
Economics
Where a company over a period of time consistently pays premiums which exceed the amounts recovered through insured losses, it is obviously beneficial to be able to capture the profits which have previously been earned by commercial insurers.
Cost Reduction
In addition to benefitting from controlling the premium paid to the captive, it should be possible to attain further cost reductions.Although captives will incur certain operating expenses they should be lower than the expenses incurred by commercial insurers. Reductions result from the elimination of the profit element built into premium charged by commercial insurers and reduction of expenses through the avoidance of high sales, marketing and administration costs of commercial insurers
Better Insurance Protection
Cyclical changes in the insurance markets, poor underwriting results, and a reluctance to insure certain types of risk may result in some lines of insurance being unavailable, other than at unacceptable high premium levels. A captive insurance company may be the only way to insure such risks.
In addition, few restrictions are placed on captives formed in offshore jurisdictions and therefore they can write policies which the conventional market is unable to offer. This would include such risks as losses due to strikes, confiscation of assets, devaluation, war risks, product recall and guarantees.
The necessity to insure risks not obtainable in the commercial market has forced various industries and professional bodies to form their own industry or profession controlled insurance companies. Such companies can provide additional expertise in the prevention and settlement of losses since members of such groups are obviously familiar with the complexities of their own industry or profession. Members can also exchange information and ideas that enable them to minimise risks usually associated with the particular industry or profession.
Improved Cash Flow
The captive has the use and benefit of the premiums. The timing of premium payments to best suit the parent can provide significant cash flow benefits not available in the conventional market.
Investment of Premiums
As the captive will have control over the premiums, its investments may be made according to the sound business judgement of its own Board of Directors or Investment Advisors. While the selected domicile Government usually has the power to prescribe that investments of a specified class require the prior approval of the Insurance Regulator and that investments of such a class already held be realised within a specified period, in practice the power to limit investments is only exercised where the particular circumstances warrant prudent intervention.
Tailoring of Insurance Programs
Instead of accepting "off the shelf policies" insurance programmes of multinationals or associations may be designed to meet the precise requirements of the shareholders.
Access to Reinsurance
A captive has direct access to the reinsurance market where companies work on lower expense ratios than direct insurers. Thus reinsurance can be obtained at a lower cost than conventional direct insurance. Reinsurance ceding fees and profit commissions may also be earned which may further reduce the cost of insurance.
Favourable Regulation
The main offshore domiciles do not have the restrictive governmental regulation with which conventional insurers and domestic captives must normally comply.
Taxation
All businesses welcome tax benefits but captive insurance companies are formed primarily because of lower insurance costs, greater cash flow, broader forms of coverage and higher limits of insurance. These are the real incentives.
If tax benefits should be available in the domicile of the parent organisation, the main offshore domiciles offer an additional advantage. There are no income taxes, corporation taxes or premium taxes, and the government offers a twenty year renewable guarantee against the imposition of any tax to be levied against profits, income or gains.
Whether or not tax benefits are available depends, of course, on the tax laws of the domicile of the parent organisation. Obviously, competent tax and legal advice should be obtained in that country.