Financing risk through mechanisms other than traditional insurance becomes important when you want to maintain overall control of your risk management program. The alternative risk market traditionally includes captives and elements of self-insurance, such as large deductibles or self-insured retentions.

What is a captive?

A captive is an insurance company established by one or more organizations, and whose main purpose is to insure the risks of those organizations.

There are different types of captives

• A single parent captive which insures related risks only.
• A group or association captive which is owned by the group or association members and insures the risks of the group or association only.
• An agency captive which is owned by an agency or broker which reinsures a portion of their client risks.
• Open market captives which write unrelated business.
• Segregated account companies or protected cell companies, which provide legal separation of assets and liabilities of separate programs.

Reasons to form a captive insurance company

There are many reasons for starting or continuing to use a captive insurance company. These reasons tend to change in priority over time as the needs of the owners evolve. Today, cost and capacity are key drivers for the use of a captive insurance company.

Why establish a captive?

Forming or participating in a captive can allow you to reap a number of benefits:

• Stable capacity
• Cost reductions
• Cash flow
• Access to reinsurance
• Unbundling of services
• Risk control discipline
• Taxation

Evaluating if a captive makes sense for your organization

To examine whether a captive makes financial and/or strategic sense, a feasibility study should be conducted. If the results of the feasibility study are positive, a more formal business plan is then developed.

Prerequisites for Success

Many captives may fail even before they commence operations. To ensure the success of your captive, the following prerequisites should be in place:

• Management Commitment
• Risk Control
• Risk Identification and Evaluation
• Market Factors
• Management Services
• Group Captive

Conclusion

While captive insurance companies can be valuable strategic tools, they are not always the best approach for every organization. In fact, in about one in four cases, they are found not to be feasible. Therefore, an organization considering a captive should follow a methodical approach to determine whether a captive is the right solution. In addition, it is important for any organization considering a captive to hire professionals experienced in actuarial, accounting, tax, and legal issues.