REASONS TO FORM A CAPTIVE

Transcription

1 REASONS TO FORM A CAPTIVE 1. Reduced Reliance n Cmmercial Insurance As the captive matures, its surplus grws, giving it greater capacity t retain risk. Increased surplus als creates new pprtunities fr accessing reinsurers and entering pling arrangements, which further increase available capacity. 2. Reductin f the Csts f Risk Management The price f insurance cverage purchased in the cnventinal market typically reflects a significant markup t pay fr the insurer's acquisitin csts (including marketing and brker cmmissins), administratin, and verhead as well as prfit t the insurer. The fact that premiums are paid in advance represents a lst pprtunity t earn investment incme. Establishment f a captive cannt eliminate these csts, but it can reduce them. The extent f the reductins will depend n the captive's wn lss experience, the claims handling csts and the degree t which the captive prmtes cst cnsciusness and efficiency in the parent. 3. Stabilizatin f Pricing Where the insured enjys a stable and reasnable lss experience frm year t year, a captive affrds the ability t price insurance cverage accrdingly. By cntrast, the cnventinal insurance market will ften set prices in relatin t brad industry classificatins, and thereby fail t reflect key differences in lss experience amng individual insureds. The result is price vlatility based n general market cnditins and the actins f ther insureds. In additin t the stabilizatin f pricing ver time, there are als advantages t be realized in terms f the rganizatin's financial planning and cntrl functins. 4. Prvisin f Cver Where Otherwise Unavailable Frm time t time, the cnventinal market is unwilling r unable t prvide cver fr certain risks, especially fr liability and casualty lss. The establishment f a captive (r grup captive) t write such lines r t prvide additinal capacity can be an answer t these market prblems. Cverage, which have at times been unavailable r difficult t btain n satisfactry terms, include prduct liability, prfessinal liability, and il pllutin, hazardus waste and labr strike insurance. Whenever insurance cver is unavailable r verpriced, the feasibility f a captive is enhanced

2 5. Access t Reinsurance Markets Because reinsurers generally deal with insurance cmpanies, a captive affrds direct access t the internatinal reinsurance markets. In bypassing cnventinal insurers, the insured is spared markup csts. The savings assciated with eliminating these csts will frequently utweigh the incrpratin and ther startup csts f a captive. 6. Imprved Cash Flw Benefits The ability f a captive t generate investment incme frm unearned premiums received is ften a critical advantage in frming a captive. This is especially s where premiums are paid in advance and lsses are paid ut ver a lengthy perid f time (which, in turn, depends n the kinds f risks insured). T the extent investment incme can accumulate in a tax-free dmicile, there will be additinal funds available t pay lsses and a crrespnding reductin fr further funding f the captive. 7. Reductin f Gvernment Regulatins and Interference By cntrast t the rigrus insurance regulatin in mst industrialized cuntries, a dmicile can prvide a less nerus, yet respnsible, regulatry framewrk. This has been described as a system f shared regulatin, whereby the regulated cperate with a view t achieving the mst apprpriate level f plicyhlder prtectin while at the same time permitting the captive t grw and prsper. 8. Ability t Custmize Insurance Prgrams A captive has cmplete freedm t insure any risk it chses and t custmize the terms and cnditins f its plicies. This can lead t imprved lss cntrl efficiency and prmte greater awareness f the factrs that cmmnly give rise t lsses. 9. Frmalize the Allcatin f Deductibles fr Self-Insurance Retentin within a Crpratin A medical facility may want t allcate csts t lcatins by lss ratis while a real estate partnership may need t bill each partner its respective cst (rather than an arbitrary allcatin). With a captive, it is easier fr the smaller entities t justify these expenses

3 10. Underwriting Advantages Inherent in Captives A key advantage f a captive is its ability t prvide management infrmatin acrss a spectrum f disciplines. Amng these is an ability t analyze histrical claims infrmatin. When feasibility studies are undertaken, it is nt uncmmn t find that precaptive lss experience is unreliable. Depending n the risk invlved, a wide range f sphisticated, analytical tls can be emplyed t help calculate IBNR (Incurred But Nt Reprted) lsses. On a day-t-day basis, simple spreadsheets can be maintained and used. These tables can be enhanced t shw numbers f claims and differentiate between paid and utstanding amunts s that the cash flw effect may be mnitred. It s simple and effective when its limitatins are understd: The cmpsitin f the prtfli may have changed ver the years. The methd f reserving may have altered ver time, especially because it is ften based n human, nt scientific, judgment. Deductibles may vary year t year, distrting the infrmatin. A yearly security lading variable that tries t track judicial inflatin, currency mvements, and the unexpected may have been added. A significant advantage in maintaining this type f recrd is its appeal in explaining t nn-insurance peple the methd f determining IBNR levels. Because f the uncertainty assciated with tail business and risk f a catastrphe, it may be apprpriate fr a captive t purchase aggregate excess f lss r stplss prtectin. In sme cases, it may be necessary t engage the prfessinal services f a qualified actuary. In either event, be aware f and mnitr what is happening t the captive in rder t maximize its value t the parent and t supprt a prudent assessment f future premium requirements. 11. Opprtunities fr Imprved Claims Handling and Cntrl A captive is als free t establish its wn claims handling plicies and prcedures. This has bvius advantages such as the reductin f the time taken t prcess and pay claims

4 12. Creatin f a Prfit Center T the extent a captive might ffer insurance cverage t unrelated custmers (smetimes in respnse t tax planning bjectives f the captive), it will have diversified int pen market peratins nt unlike cnventinal insurers. Althugh there are special risks and capital requirements assciated with engaging in such business, ding s will have the ptential t generate additinal prfits. 13. Tax Advantages While prfessinal tax advice shuld be sught befre making the decisin t frm a captive, there may be certain tax advantages assciated with such a decisin. These might include the tax-favred accumulatin f underwriting and investment incme (which may depend n, amng ther factrs, the dmicile f the captive, the residence r citizenship f the captive s wners r the surce f its incme). Anther advantage may be the deductibility f premiums paid fr by the insured fr tax purpses (as premium expense f the insured). Als, if a captive qualifies as a true insurance cmpany fr tax purpses, then unlike ther crpratins it can deduct currently a reasnable and fair lss reserve fr unpaid actual lsses incurred. Finally, state premium taxes therwise payable in a cmmercial insurance prgram may be reduced. Althugh tax advantages may be f significance in the decisin t frm a captive, they shuld never be the prime-mtivating factr. 14. Ability t Direct Investment Optins Generally when yu purchase cmmercial insurance yu d nt cntrl the investment f the premiums. A captive can affrd the pprtunity t direct these investment chices

5 SOME POSSIBLE DRAWBACKS 1. Administratin Increased Administratin Burden: The captive wner(s) will be ultimately respnsible fr such items as claim administratin, lss cntrl and underwriting. Additinal time, mney, persnnel and management cmmitment is required fr these services. Such csts may be ffset by cntracting ut administratin t captive management cmpanies. Hwever, these csts will reduce the premium savings expected in cmparisn t cnventinal insurance cmpanies. Delegatin: Where a captive management cmpany is engaged, a high degree f delegatin and partnership is required. A significant management time cmmitment is invlved, but if the parent cmpany already emplys a risk manager, this time cmmitment shuld be within the nrmal arena f such a manager's duties. Acquisitin f Expertise: A parent cmpany must acquire relevant expertise fr all the insurance related disciplines. This culd be ffset by the engagement f captive management services, althugh it wuld be prudent t have a least sme expertise residing in the parent cmpany. Merger r Acquisitin: A captive s existence may cmplicate merger r acquisitin activity. 2. Financial Vlatility f Reinsurance Market: Generally speaking, the reinsurance market acts mre swiftly than the primary insurance market in the event f adverse experience. Since the reinsurance market tends t be experience rated (premiums clsely reflect the lss histry f the insured) a reinsured risk f a captive might face premium increases sner than a cmmercially insured risk. Capital Cmmitment: At least during the initial stages f a captive frmatin there will be a burden n the parent's financial resurces t fund the initial set-up csts and the capitalizatin required by the dmicile's regulatry bdy. Run-Off: A change in the parent cmpany s business plan r a merger might result in the captive being placed in a run-ff mde. Expenses f a run-ff prduce n current ecnmic benefit. Fr mre infrmatin cntact Cnr Jennings at: Phne: cjennings@captivamanagers.cm - 5 -