Insurance terminology
The
global insurance industry has seen a significant change in its role and
competitive structure over the last two decades with international banks
and financial service companies presenting competitive threats with their
offering of new insurance products.
The
Bermuda insurance market took the lead role on the global stage with an
increasing presence through market expansion and acquisition and is second
only to the City of London for insurance in the world. One of the
key ways it
has achieved this is through the development of the
innovative concept of
“captive” insurance companies.
Captives
A captive insurance company is defined as
"a closely held insurance company whose insurance business is
primarily supplied by and controlled by its owners, and in which the
original insureds are the principal beneficiaries”. In
layman's terms, a
captive is an insurance company formed exclusively to insure
(or reinsure)
the insurance risks of its parent corporation.
What is the point of a captive?
Major Fortune 500 corporations (e.g. Coca Cola or Boeing) will set up a captive of their own in order to better control
- and minimise - their own insurance bill (e.g. premium that would otherwise
be paid out
to a third-party insurance provider to cover workers' compensation claims
for accidents in the work place). In this way, they hope to reduce costs from insurance
claims (by adopting a rigorous vetting procedure on all claims) as well as
gain access to the reinsurance market (better premium rates) and
have the option to decide for themselves where to invest the premium dollars passed down to
the captive entity (thereby possibly avoiding third-party investment
management fees).
It is a huge financial market: Globally,
captives generate $18 billion in annual premium. Their capital and surplus
amount to $45 billion and they control investment assets of more than $100
billion. Captive insurance and reinsurance companies are an integral part
of the alternative risk transfer market, which accounts for approximately
30% of global commercial premium. In all, some 4,000 captives serve their
parents' risk financing needs around the world, and this number is growing
steadily, in Bermuda and other leading offshore financial centres in the
Caribbean such as Grand Cayman and the BVI.
One
of the functions of a captive is to facilitate the efficient financing of
risk within an organisation. Captive owners can be found in a wide range
of sectors including multi-national corporations, associations, banks,
municipalities, transportation companies, power producers,
telecommunication companies, shipping companies, airlines and insurance
companies.
A
captive serves as a sophisticated in-house risk carrier. It can be used
both as a weapon and a shield to control the upswings and downturns in the
commercial market. A captive can bypass many of the problems and
frictional costs inherent in the insurance industry. It can be an
important co-ordination tool for risk managers. A captive forms part of
the overall financial planning of a corporation or organisation, and
through the captive, risk management issues are brought to the attention
of executive management.
A
captive can operate as a direct insurance company, issuing policies to
subsidiaries in a group, or it may serve as a reinsurance company,
assuming risks behind commercial insurers. Captives traditionally
underwrite property & casualty risks, but to an increasing extent are
also involved in life assurance and employee benefit schemes.
The
commercial insurance industry can be slow in meeting new needs and
embracing new concepts. For many captive owners, increased awareness of
risk management problems has paid off in loss records that are
substantially lower than industry average, especially those used to set
commercial rates. Many corporations, groups and other organisations have
formed their own insurance subsidiaries (i.e. captives), rather than being
penalised by higher premiums based on the poor loss experience of other
companies in their respective industries, and have gained many risk
management and financial benefits.
Captive
benefits
Underwriting
profit
With
a captive solution, the underwriting profit goes directly to the captive
and thus flows back to the parent, not the commercial insurance carriers.
Improved
cash flow and investment return
By
controlling the captive's premium and loss reserves and
investing premium funds in the stock market, substantial
investment income can be earned by the captive. This income would
otherwise go to commercial carriers.
Reduced
overall cost of coverage
Premiums
paid to the captive are no longer used to subsidise the commercial
carriers' overheads and profits. This contributes to a lower premium.
Also, premium rates in a captive are typically calculated according the
the parent's own claims activity history and not set by industry-wide
standards.
Access
to the reinsurance market
A
captive provides an entirely new avenue through which to obtain wholesale,
lower
premium quotes not offered by primary insurance carriers.
Unbundled
support service
From
the owner’s perspective, with a captive it is possible to pick and
choose the optimum combination of claims settlement, policy issuance,
reinsurance protection and loss control.
Access
to otherwise unaffordable or unavailable coverage
A
captive has the ability to provide tailor-made policies and coverage – a
feature that is often difficult or impossible to obtain from the
commercial market.
Co-ordination
of global exposure
The
use of a captive can be complementary to the centralisation and efficient
control of a multi-national insurance program.
Rent-a-captives
The
captive insurance mechanism explained above is based on a sound concept and has a proven
track record of success. However, the
implementation and daily administration of this formalised
self-insurance vehicle requires in-depth knowledge and experience
of the insurance sector.
Certain major corporations may have the know-how and resources
to administer a captive internally, but many prefer to outsource their
captive management to a professional service provider specialised in this
area. Similarly, smaller and mid-sized companies can
get virtually the same benefits of owning a captive by also following
this route. Accordingly, the concept of non-owned captives or
“rent-a-captives” has gained popularity in recent years.
An
added plus is the investment income earned on the rent-a-captive program.
This is related to the time delay on the payment of incurred losses. For
example, liability losses incurred in a specific underwriting year may
actually be paid over a five to ten year period or longer. During this
time these funds, with premiums now in the form of loss reserves, remain
available for investment and the rent-a-captive participant, not the
commercial carrier, will be entitled to the income derived.
>
Click here for more on cashflows of captives and
rent-a-captives
>
Click here for
more on the offshore regulatory
environment in Bermuda
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