A Guide to Starting and Running a Captive Insurance Company

Starting a captive insurance company can be a complex process, but it's a great way to manage risk and save money on insurance premiums. It requires a significant upfront investment, typically ranging from $500,000 to $5 million.

A captive insurance company is a subsidiary of a parent company, formed to insure the parent's risks. This can be a cost-effective way to manage risks, as the captive can offer lower premiums than traditional insurance companies.

To start a captive, you'll need to file a certificate of incorporation with your state's insurance department. This typically involves paying a filing fee, which can range from $500 to $5,000, depending on the state.

Captive insurance companies are subject to strict regulations, including annual audits and financial reporting requirements. This ensures that captives operate with transparency and integrity.

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A captive insurance company is a form of corporate self-insurance. It's a way for a parent company to provide insurance services to itself, essentially insuring its own risks.

This setup can be beneficial, especially when it comes to keeping money that would otherwise be spent on additional insurance premiums. However, there are administrative costs to consider, such as hiring additional personnel and covering startup costs.

Captive insurance companies often rely on traditional insurers to insure against some risks, and they can also use reinsurance companies to distribute some of the risk. This helps to minimize the parent company's exposure to potential losses.

Captive insurance companies can offer potential cost savings, which can be a significant advantage for businesses looking to manage their risk.

Tax advantages are another benefit of captives, allowing companies to reduce their tax liability and increase their bottom line.

Companies that use captives have greater control over their coverage and claims, which can be especially important for businesses with unique or specialized risks.

Underwriting profits are also a potential benefit of captives, as companies can earn a profit on the premiums they collect and invest.

Here are some of the key benefits of captive insurance companies:

Regulation and compliance are crucial aspects of captive insurance companies. Captives may be licensed to write some lines of business directly, but in other cases, they must initially be written by another insurer, which then reinsures it to the captive.

In the US, premiums paid to captives are tax deductible, provided the terms of the policy are reasonable. A captive cannot arbitrarily set the premium amount to generate a deduction for the parent.

In the European Union, a new set of regulatory requirements (Solvency II) is planned with additional restrictions and responsibilities for captives and reinsurance companies. Some European captives ask for simplified regulation.

Here are some relevant Florida Statutes that govern captive insurance companies:

Bermuda is the world's leading offshore captive domicile, with 958 captives licensed as of 2008, accounting for 19.3% of the total. This is due to its geographical location, clean reputation, and status as a British Dependent Territory.

The Cayman Islands is the second largest licensing jurisdiction, with 765 captives licensed in 2008, making up 15.4% of the total. Vermont, on the other hand, is second in terms of insurance company assets but third in terms of captives licensed.

Luxembourg is the largest captive reinsurance domicile in the EU, but its exact number of captives is not specified. Healthcare corporations prefer Bermuda due to the ease of claim payment provided by the regulatory environment.

Here are the top 10 captive domiciles, ranked by the number of captives licensed:

Note that some jurisdictions, such as Anguilla and Montana, are not included in this table due to the lack of specific data.

Special purpose captive insurance companies are unique in their structure and purpose. They don't fit into any other category of captive insurance company.

One type of special purpose captive is the Special Purpose Captive Insurance Company, which is designated as such by the Commissioner. This type of captive can be thought of as a license for a structure that's similar to an agency or group captive.

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A Special Purpose Financial Captive Insurance Company is formed to reinsure the risk of an affiliate or parent, often a life insurance company. They issue reinsurance contracts to their parent or affiliate, and then cede the risk to the capital markets.

Special Purpose Captive Insurance Companies can be licensed as a special purpose captive, giving them a unique designation. This allows them to operate in a specific way that's different from other types of captives.

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Regulation of captives is a crucial aspect to consider. Captives may be licensed to write some lines of business directly, but in other cases, they must initially be written by another insurer, which then reinsures them to the captive.

In the US, for example, workers' compensation is a business that must be written by another insurer, which then reinsures it to the captive. The original insurer retains a fee, usually between 5% and 15%, to provide this service.

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Premiums paid to captives are tax deductible, provided the terms of the policy are reasonable. This means the captive cannot arbitrarily set the premium amount simply to generate a deduction for the parent.

In the European Union, a new set of regulatory requirements (Solvency II) is planned, which will impose additional restrictions and responsibilities on captives and reinsurance companies.

Here are some key regulatory requirements for captives in Florida:

These requirements are outlined in the Florida Statutes, specifically in sections 628.901-628.920.

Setting up a captive insurance company requires thorough research and planning. Every company has unique needs, so a tailored approach is essential.

To determine if a captive is feasible, you'll need to conduct a feasibility study. This will help you understand the potential risks and benefits of a captive operation.

A well-planned captive structure is crucial for success. You can work with experts to assist with various aspects of the captive establishment process, including risk management studies, tax structuring, and regulatory consulting.

Here are some key areas to consider when setting up a captive insurance company:

A protected cell captive insurance company is a type of captive that consists of a core and multiple cell entities.

Each cell has its own dedicated assets and liabilities, which are segregated from the other cells. This means the assets of one cell can't be used to pay the liabilities of another cell.

This structure is attractive to smaller organizations because it allows them to manage their own risk without establishing a full-fledged captive insurance company.

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Making Early Choices is crucial when setting up a captive insurance company. You need to thoroughly research and properly plan every aspect of your captive operation.

Every company has different needs, so it's essential to tailor your captive structure accordingly. This means considering factors such as feasibility, risk management, and tax structuring.

A feasibility study is a great place to start, helping you determine whether a captive is right for your business. It's like conducting a market research before opening a new store - you want to make sure there's a demand for your product.

A risk management study is also vital, as it helps you identify and assess potential risks associated with your captive operation. This will inform your decision-making and ensure you're prepared for any challenges that may arise.

Tax structuring and opinions are also important considerations, as they can have a significant impact on your captive's financial performance. You'll want to work with a tax expert to determine the most beneficial structure for your business.

Here are the key aspects of the captive establishment process:

Risk management studies;

Tax structuring and opinions;

Actuarial and reserving assistance;

Accounting guidance;

Formation assistance;

Regulatory consulting.

Captive management is a specialized field that requires expertise in insurance, tax, and law. Most captive managers are small administrative services providers that don't draft insurance policies or price them.

In the US, captive management is often outsourced to a captive manager located in the jurisdiction that holds the primary license for the captive. This can be a cost-effective way for companies to manage their captive insurance arrangements.

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More than 90% of Fortune 500 companies already have captives, according to Capstone Associated Services Ltd. This is driving growth in the middle market for captive managers. They provide a full turnkey service to include all aspects of forming and managing a captive insurer on an ongoing basis.

Captive insurance companies are creatures of the Internal Revenue Code, and over 75% of the world's captives are associated with the United States. This is because the Internal Revenue Code encourages the use of these insurance arrangements.

Businesses should periodically review their captive operations to determine if it continues to meet their needs under current circumstances. This is especially true if the business has undergone changes such as acquisition, divestiture, or the launch of new businesses or operations.

Captive insurance companies are often used by large corporations to self-insure their risks, such as product liability or employee compensation claims.

This approach allows companies to better manage their risks and reduce costs associated with traditional insurance policies. Captive insurance companies can also provide more flexible and tailored coverage options.

In the United States, captive insurance companies are subject to state regulations, with some states having more favorable laws than others.

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BP was self-insured by Guernsey, U.K.-based captive insurance company Jupiter Insurance, which could provide up to $700 million in coverage for losses.

Most Fortune 500 companies today have captive insurance subsidiaries.

The state of Tennessee launched its own captive insurance company in 2022 to cover state-owned buildings and contents, including Tennessee's public college campuses, as well as general liability.

The captive insures property valued at $31.4 billion as of July 2022.

Micro captives are smaller entities with annual written premiums up to $1.2 million.

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Over 90 percent of Fortune 1000 companies use captives, a trend that has also been adopted by many successful middle market businesses.

A Section 831(b) or "small" property/casualty captive, also known as a "micro-captive", is a cost-effective way for midsize companies to transfer risk.

These captives have been a popular choice for middle market companies since the early 2010s, providing a valuable cost-saving tool long utilized by Fortune 1000 companies.

However, some companies have misused this option by paying premiums up to the statutory deduction limit to entities that don't actually pool risk.

This misuse has led to enforcement actions against clients by the IRS.

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The insurance market has become increasingly hard to navigate, with higher rates in almost all lines. This is especially true for companies trying to purchase or renew insurance policies.

The COVID-19 pandemic and natural catastrophe losses have made the situation worse, driving up costs even further. The pandemic has caused unprecedented disruptions to businesses worldwide, leading to a surge in claims and a subsequent increase in insurance premiums.

Captive insurance companies were created to help companies manage risk in difficult markets like this one. By setting up their own insurance companies, businesses can retain risk and explore alternative insurance/reinsurance options.

Higher rates in the insurance market have made it essential for companies to explore alternative risk management strategies. Captive insurance companies offer a way for businesses to take control of their risk management and potentially save on insurance costs.

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Captives can cover lines of business with relatively predictable claim rates, such as workers' compensation.

Businesses can use captives to transfer risks they don't want to accept, like product liability, general and professional liability, and directors' and officers' liability, by accessing the reinsurance market.

Vehicle insurance for corporate fleets and vehicles is another common line of business covered by captives.

Industrial insured captives insure the risks of an industrial insured group and its affiliated and controlled unaffiliated businesses, which must have at least 25 full-time employees and aggregate annual premiums of at least $25,000.

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Association insurance provides coverage for member organizations, their affiliated companies, and even the association itself. This type of insurance is often used by professional associations and trade groups.

Insuring the risks of member organizations is a key benefit of association insurance. Association Captive Insurance Company is a prime example of this, as it specifically targets the risks of member organizations and their affiliated companies.

Association insurance can also cover the risks of the association itself, which is an important aspect of managing organizational risk. This includes risks such as liability, property damage, and business interruption.

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Modernization is a crucial step in enhancing captive performance. Captive modernization involves evaluating and improving actuarial systems to make operations more efficient and cost-effective.

By modernizing captives, companies can improve data analytics, leading to more accurate reserving and risk selection. This is achieved through new modeling capabilities that harness enhanced data analytics, often hosted in cloud applications.

Streamlined data collection processes reduce administrative burden and provide a single source of truth for various stakeholders. Transparency in processes is also achieved, improving data reconciliation, financial reporting, and compliance with accounting and regulatory standards.

Modernization enables strategic policies and improves captive program flexibility as a risk management tool. It also leads to redesigned reporting approaches and tools that produce useful metrics to communicate risk trends to leadership and business units.

Here are the key benefits of modernization:

More accurate reserving and risk selection through new modeling capabilities;

Streamlined data collection processes that reduce administrative burden;

Transparency in processes for a robust internal control framework;

Strategic vs. reactive policies and improved captive program flexibility;

Redesigned reporting approaches and tools that produce useful metrics.

Captive insurance companies often use specialized software to manage their internal insurance operations, such as policy administration and claims processing.

Some popular options include PolicyWorks, a comprehensive policy administration system, and Duck Creek, a suite of insurance software solutions.

These systems can help captives streamline their operations, improve efficiency, and reduce costs.

Captive insurance companies can also benefit from consulting services, such as those offered by Aon, a global professional services firm, which provides expertise in captive insurance management.

Aon's captive insurance management services include risk assessment, policy development, and claims management.

By leveraging these resources and tools, captive insurance companies can optimize their operations and achieve their business objectives.

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