Types of Captive Insurance Companies

In its simplest form a captive can be defined as a wholly owned insurance subsidiary of an organization not in the insurance business whose primary function is to insure some or all of the risks of its parent. Since captives were first formed the industry has looked at new ways of developing the captive model to provide appropriate vehicles for a wide range of different owners and users.

There are now many types of captive, including:

• Single-parent captives, underwriting only the risks of related group companies. Diversified captives underwriting unrelated risks in addition to group business. Association captives which underwrite the risks of members of an industry or trade association. Liability risks such as medical malpractice are frequently insured in this way.
  
• Agency captives formed by insurance brokers or agents to allow them to participate in the high-quality risks, which they control.
  
• Rent-a-captives are insurance companies that provide access to captive facilities without the user needing to capitalize his own captive. The user pays a fee for the use of the captive facilities and will be required to provide some form of collateral so that the rent-a-captive is not at risk from any underwriting losses suffered by the user.
  
• Special purpose vehicles (SPV’s) are used in risk securitization. They are reinsurance companies that issue reinsurance contracts to their parent and cede the risk to the capital markets by way of a bond issue.
  
• Risk-Retention Groups (RRGs) are liability insurance companies owned by their members. Under the Liability Risk Retention Act (LRRA), RRGs must be domiciled in a state. Once licensed by its state of domicile, an RRG can insure members in all states. Because the LRRA is a federal law, it preempts state regulation, making it much easier for RRGs to operate nationally. As insurance companies, RRGs retain risk. These are excellent vehicles for medical malpractice insurance.

Captives may be established as direct-writing companies issuing policies to, and receiving premiums from, their insureds but the insurance industry is generally highly regulated and, in many jurisdictions, certain risks may only be written by an admitted insurer. Usually, and particularly in the case of smaller captives, it is simpler for the captive to operate as a reinsurer accepting the risks of its parent, which have been insured by a licensed direct-writing company (a ‘fronting company’) and then ceded to the captive. The fronting company will charge a fee for its services and may require a letter of credit to guarantee the captive’s ability to pay claims.

In addition to the types of captives, a few of which are outlined above, captives can fall under different tax and regulatory regimes. Captives can be taxed as U.S. companies, or may choose to be taxed as a foreign company. Captives can be formed in several states in the U.S., or can choose from one of several competent offshore jurisdictions, including Anguilla.

To learn about the ideal clients for AIM and captive insurance, click here.

To learn more about the specific reasons for forming a captive insurance company, click here.