A “captive” insurance company (captive) is an insurer formed to participate in the insurances of its parent organisation (parent) or of a specific generic group, the latter of which is normally tied by some common bond, either economic, trade or social. In most respects it operates as a normal insurance company, although generally it only accepts risks from its parent.
The following describes the numerous advantages of forming a captive.
Risk financing
A captive assists the parent to control the financing of its risks, its insurance programme and structures, and its relationships with external intermediaries and underwriters. An organisation that decides to set up and run a captive increases awareness and implementation of its risk management skills and techniques. This applies to an organisation of any size, enabling it to lower costs directly through reductions in losses and claims.
Increased risk awareness
Retention of risk, when carried out in a formal manner, brings an increased awareness of risk management throughout the parent. Regular review of financial results engenders risk awareness and rapidly identifies any adverse consequences. Identified risks can then be managed better, thus assisting in the continuous risk management cycle.
This creates a culture of accountability, in which risk financing contributions (premium) are treated as an asset to be preserved.
Ownership of risk
Organisations display a protective attitude towards their captive and other retained funds. They recognise that these funds belong to the parent and have not been paid out to a third party, and that the premium must produce a return to give value for money. In addition, a captive that participates at the primary level of risk demonstrates a commitment to minimise losses and thus strengthens the parent’s negotiating position in the commercial insurance market.
Reducing administrative costs
Compared to the commercial market, a captive has the advantage of maintaining control over its administrative costs, which make up a significant element of the premium cost and eliminates marketing costs. Captive management is generally outsourced, with the parent controlling the expense margin. Overheads such as underwriting and claims expenses will be lower and are specific to the risks being accepted, rather than generic to the overall insurance community needs.
Long-term view
By owning a captive, the parent can take a long-term view on funding risk, with its annual profit and loss not under the pressure of external insurers. To some extent a captive can insulate its parent from the volatility of insurance market pricing. In a soft market, a captive should be able to purchase reinsurance at competitive rates; whereas in a hard market, it can utilise any retained profits to take a greater share of risk itself, thus “smoothing” the parent’s funding costs.
Owner-specific costs
Utilising a captive allows a parent to calculate the cost of risk to be retained, and to fund the impact of any claims over a number of years. Risks are owner specific and insulated from the claims pattern of the general insurance marketplace, which loads the cost of other parties’ losses into premium calculations. At higher levels of risk, insurance or reinsurance protection may be needed, but such cover is often more properly priced on true catastrophe perils.
Tailored insurance coverage
A captive can be used to finance:
- difficult or unfashionable risks and emerging risks, or risks that are relevant to the parent but for which there may not be much insurance market interest due to the size, nature or complexity involved. Often a form of industry or trade mutual agreement is utilised to assist in spreading the financing cost and risk assumed by such a vehicle
- individual risks, which are small in themselves, but can be combined to include losses of considerable amounts, invariably involving too much aggravation to justify commercial cover, even on an aggregated basis
- unusual risks, which are peculiar to the parent rather than a collection of organisations
- tailored insurance covers, provided evidence can be shown that appropriate risk management procedures are in place.
User applications are changing. Increasingly, captives are being used by larger corporations to enhance core products. This structure also plays a major role in long-range strategic planning as more and more companies seek optimum retentions and exert greater in-house control over their financial exposures.
Access to the reinsurance market
A captive can enable its parent to access the reinsurance market directly. Reinsurers have recently increased their interest in dealing with corporates and captive solutions on a direct basis, since risks are generally subject to stringent risk management standards and are thus better than average.
Captives in Labuan IBFC
Traditionally, captives have been set up in offshore jurisdictions to ensure cost-effective access to global reinsurance markets and to maximise investment potential for corporate funds retained within the captive. Despite international competition, Labuan International Business and Financial Centre (Labuan IBFC) has had considerable success in attracting both international and domestic Malaysian captives. As at October 2014, 40 captives were resident in the domicile. Its captive business recorded total gross premiums of USD437.5 million in 2013, an increase of 33.8% compared to USD327.1 million in 2012, mainly due to the risks underwritten in the engineering sector.
Labuan IBFC has an aggressive approach to its expansion as a captive domicile based on:
- A mature, pragmatic and business-friendly environment
- Sound legislative and administrative structures
- Well-established international banking, investment and communication systems, and
- A broad range of experienced service providers.
Examples of risks that have been managed by Labuan-domiciled captives include:
- Marine (ships, barges)
- Oil and gas
- Extended warranty of products
- Personal accident