What Is Captive Insurance? Definition and Management

What Is Captive Insurance

Captive insurance business is a corporation formed and managed by a parent with the primary goal of providing insurance to the parent firm.

The theory behind this strategy is that the parent firm can save money on overhead costs and profits that the insurance company would otherwise charge.

In addition, insured companies claim premiums as expenses, which may result in possible cash flow advantages.

What Is a Captive Insurance Company?

A reinsurance pool, which was intended to boost underwriting capacity by pooling risk, could be this type of heterogeneous group captive. If the parent company cannot find a suitable outside firm to insure them against specific business risks, if the premiums paid to the captive insurer result in tax savings, if the insurance provided is more affordable, or if it provides better coverage for the parent company’s risks, a captive insurance company may be formed.

A captive insurance firm is not to be confused with a captive insurance agent, who works for only one insurance company and is prohibited from selling products from other companies.

Insureds who opt to use captive insurance do so.

  • To fulfill their risk financing goals
  • they put their own money on the line by forming their own insurance firm
  • operating outside of the commercial insurance market.

Reviewing these three key characteristics of captive insurance will help you understand what a captive insurance company is all about.

Understanding the Captive Insurance Company

A captive insurance firm is a type of “self-insurance” for businesses. While there are financial advantages to forming a separate organization to provide insurance services, parent companies must factor in the administrative and overhead costs, such as additional people. Compliant difficulties are also a factor to consider. As a result, larger organizations are more likely to form captive insurance companies, while they may also use third-party insurers to cover specific risks.

The Purpose of a Captive

While it is true that one of the purposes of a captive insurance company is to create revenue, this is not the primary reason, nor can it justify the formation and continuous operations of a legitimate insurance company to all parties.

To be clear, the aim of an insurance firm, and hence a captive, is to cover losses (your own losses) and provide you (the owner) greater control over your risk and any losses that do arise.

Captives, to put it another way, are an alternative risk transfer mechanism that is used to fund risk. They aren’t intrinsically mysterious or unlawful, but they’re also not a panacea for all problems. The fact that the insured, or a closely linked organization, is the owner/operator is a separate and independent fact that may or may not have an impact on the captive transaction.

Why Do Captive Insureds Risk Their Own Money?

Any insured who buys captive insurance has to be willing and able to put their own money into it. In a captive insurance firm, the insured not only owns and controls the company but also benefits from its profits.

A mutual insurance business’s policyholders are theoretically entitled to dividends if the company generates a profit. Mutual insurance businesses, on the other hand, tend to hoard rather than disperse their surplus.

Determining the Feasibility and Goals of a Captive

An actuarial analysis or feasibility assessment of your loss history and historical claims is the first step in building a captive. This will identify your company’s accepted loss level and claim level, as well as provide obvious trends and attachment points for premiums, expenses, and reinsurance. It also aids in determining whether forming a captive is the best option for you. It is critical to assess early on in the creation process whether the suggestion to use a captive would result in a long-term solution.

Increased control over premium fluctuations and market changes, more flexibility of choice between vendors and service providers, reinsurance structure choices, personal tax advantages, and maybe even the creation of a new profit center are among the additional reasons. While it’s difficult to put a monetary value on these factors, they can have a significant impact on the cost-effectiveness of a captive.

How To Achieve Risk Financing Objectives

When insurers’ product fails to meet an insured’s risk financing needs, forming a captive insurer may be the best choice. Excessive price, limited capacity, coverage not accessible in the “conventional” insurance market, or a need for a more cost-effective risk financing mechanism is the major reasons why businesses want to better control their risk management programs. Captive insurance can also be used for other reasons.

Service Provider Selection

Additional service providers will need to be chosen after the domicile selection. A captive manager, a reinsurance broker, a third-party administrator (TPA), an attorney, an accountant and tax adviser, a banker, and, of course, an actuary will need to be engaged and employed, depending on the characteristics of the captive in the issue.

Officers and directors are required because a captive is a company or corporation. Incorporation and the writing of bylaws and other formal operating documents can be handled by the captive management and/or the attorney.

To guarantee that the directors and officials are in good standing, most domiciles need some referencing. Regulators should simply regard this as cautious caution, and it frequently entails a background check, as well as Internet and court searches. Money laundering rules and responsibilities.

Broader Coverage

Many captives are formed because commercial insurance is either unreasonably expensive, poorly fitted to the needs of the insured, or unavailable. As long as the captive operates within sound underwriting, actuarial, and regulatory parameters, it can successfully provide coverage for difficult risks that are tailored to the particular needs of the insured(s).

Improved Cash Flow

Cash flow improvements can be achieved in a variety of ways. Underwriting earnings are lowered or eliminated when losses are kept through a captive; profits are increased when losses are reduced. Because captive insurance intrinsically rewards successful loss control with cash rewards, safety and loss control receive a higher level of attention.

The captive keeps the underwriting income and gains on the invested premiums that would otherwise go to a conventional insurer. Due to the enormous levels of capital and excess routinely kept, even in conservative investment portfolios, the monetary amounts are significant.

Finally, by lowering the expense components associated with business insurance, cash flow is improved. In general, insurers devote 60% or more of premiums to loss payments, with the remaining 40% or so covering expenses and profits.

Commercial insurers have considerably more expenditure components than captive insurers. Captives’ expense components are often estimated to be between 15% and 30% of the total cost. This indicates that a successful operating captive can save insureds $1 million to $2.5 million in expenses alone for every $10 million in net written premium.

Increased Control over the Program

A captive insurer differs from a commercial insurer in that it is owned and controlled by its insureds. A nominal percentage share in the company’s excess does not demonstrate this form of ownership or control. It entails taking responsibility for the company’s strategic business goals.

Captive insurers also give you more power in a variety of different ways. For example, captive owners have more control over insurance-related services such as safety and loss prevention, as well as claims administration. Safety and loss control services provided by a captive can be tailored to the unique needs of each participant, resulting in safer workplaces and a better loss experience. Claims handling services are separated and arranged independently.

The captor can draft and enforce strict guidelines. Allowing a commercial insurer, whose interests may be more self-serving than an insured’s, to decide how claims are handled is preferable.

What Are The Two Types Of Captive Insurers

Pure captives: 

Captives that only insure the risks of their owner or owners are referred to as “pure captives.” There is only one owner for single-parent captives. Multiple people own group captives.

Another type of group-owned captive permits a group of insureds from various industries to jointly own a captive. A reinsurance pool, which was intended to boost underwriting capacity by pooling risk, could be this type of heterogeneous group captive. Direct insurance is not provided by a reinsurance pool.

It either reinsures its owners’ captives or the admitted insurers who issue policies to the pool’s owners. Other risk management services may be provided by the group captive or pool.

Sponsored captives:

Sponsored captive insurers, often known as “nonowned” or “nonaffiliated” captives, share many similarities with pure captive insurers. The captive’s insureds are obliged to put their capital at risk, risks are funded outside of the commercial regulatory framework, and the purpose is to achieve the captive’s insureds’ risk financing goals.

A sponsored captive may be established by an insurance industry-related business for the use of its clients, or there may be no prior relationship between the sponsor and the captive participants. The captive’s statutory capital comes from the sponsor (sometimes called core capital). Many sponsored captives only charge an access fee rather than requiring insureds to pay capital. “Rental captives” is a term that is sometimes used to describe them.

The key difference between a pure group captive and a sponsored captive is this. A sponsored captive can be set up to have legally independent underwriting accounts, whereas an insured who is a member or owner of a pure group captive shares risk with other captive insureds. 

Insureds who are shareholders or members of an industrial insured group captive must invest capital in order to participate in the captive insurance program, and their capital is at risk if the group as a whole performs poorly. Each participant’s risk capital in a sponsored segregated cell captive is normally solely exposed to the risk of its own underwriting performance.

Tax Issues of Captive Insurance Companies

A captive insurance company’s tax structure is straightforward. The parent firm pays its captive insurance company insurance premiums and tries to deduct these payments in its home nation, which is frequently a high-tax state.

The type of insurance the captive insurance company transacts will depend on the classification of insurance whether the parent company receives a tax saving as a result of its formation. Risk distribution and risk shifting must be present for a transaction to be classified as “insurance” in the United States, according to the Internal Revenue Service (IRS).

Working Outside the Commercial Insurance Marketplace

Captive insurers prefer to risk their own money by acting outside of the typically regulated commercial insurance marketplace. The traditional regulatory environment for insurance tries to “protect” the insured from the insurer. Regulations are costly to implement, monitor, and enforce, and they frequently fail. Their major goal is to limit what and how insurance can do.

Which Commercial Insurance Company Is The Best?

1. State Farm (Best Overall)

Because it offers numerous types of coverage through a nationwide network of agents, we chose State Farm as the best overall small business insurance carrier. Furthermore, State Farm representatives are familiar with the demands of other small business owners because they are also business owners.

2. Hiscox (Best For Independent Contactors)

Standard liability coverage limits at Hiscox are up to $2 million, with greater levels available with underwriting clearance. The organization provides coverage for a wide range of industries and policy types at affordable monthly rates, making it a cost-effective solution for independent contractors and microbusinesses.

What Is The Difference Between Captive Insurance and Traditional Insurance?

What is Captive Insurance?

Captive insurance is a sort of self-insurance designed for companies that want more control over their insurance premiums. A captive insurance company is a subsidiary of a business owner’s company that writes the owner’s company’s insurance policy. 

Advantages of Captive Insurance

  • Savings on premiums and taxes are possible
  • Long-term financial commitment
  • Ideal for large, medium, and small businesses

Disadvantages of Captive Insurance

  • It is necessary to raise funds.
  • There may be concerns with service quality.
  • There are no tax advantages to captive insurance.

What is Traditional Insurance?

When a corporation transfers risk to a third-party company that costs a premium and needs a deductible, this is known as traditional insurance. This premium is combined with premiums received from other insured risks to create a pooled premium.

Traditional insurance companies compute your company’s premium prices by calculating the probability of risk based on the broad pool of risks they insure. Furthermore, the traditional insurer will force the insured to pay their deductible out of pocket, and your premiums will rise in subsequent years as a result of the loss and increased risk. One advantage of traditional insurance is the ease with which it can be purchased by contacting an insurance provider.

Advantages of Traditional Insurance

  • Low first startup costs
  • Premiums are tax-deductible.
  • Risk Dispersion
  • The setup is simple.

Disadvantages of Traditional Insurance

  • a higher price
  • The death benefit is reduced.
  • Inadequate investment control

Examples of Captive Insurance Companies

After the 2010 British Petroleum oil spill in the Gulf of Mexico, a well-known captive insurance firm gained headlines. At the time, reports circulated that BP was self-insured by Jupiter Insurance, a Guernsey-based captive insurance business and that it may receive up to $700 million from it. Captive insurance subsidiaries are common among Fortune 500 firms, and British Petroleum isn’t alone in this approach.

Why Do Companies Form Captives?

The formation of a captive insurance firm has a number of possible benefits. Captive insurance firms are founded for a variety of reasons, including cost-cutting and risk management. For example, in comparison to premiums paid to a traditional property and casualty insurance company, a firm can drastically reduce insurance expenses by founding a captive insurance company.

Costs for overhead, marketing, agent commissions, advertising, and other expenses can be reduced significantly by forming one’s own insurance vehicle, resulting in considerable underwriting profits that can be retained by the captive company’s owner.


A captive insurance firm resembles a mutual insurance company in several aspects. The owner(s) of a captive, on the other hand, risk their own money and have direct influence over their insurer. Owners of captive insurance companies are willing to put their own money on the line in exchange for greater financial control over their insurance program. Broader coverage, stable insurance pricing, and availability, and increased cash flow are among them.