Fundamentals of Risk Management

Risk response
204
FIgURE 
17.1
Role of captive insurance companies
Level of
cover
Type of
insurance
Primary Insurer
providing cover
to full property
values
Property
insurance
Liability
insurance
Motor
insurance
Excess insurance
layer(s) up to required
level of cover
Primary Insurer acting
as fronting insurer
Captive insurance
company
Deductible
Deductible
Some captive insurance companies accept business from third parties as well as pro-
viding insurance for the parent company. A typical example of a captive insurance 
company providing third-party insurance is extended warranty insurance policies 
offered by the retailers of electrical goods. Another example is that travel agents may 
set up a captive to provide travel cancellation insurance to customers. The customer 
will purchase a policy issued by a well-known insurance company, but the funding 
of the insurance will be provided by the captive by way of reinsurance of the fronting 
insurer. By setting up this arrangement, the travel agent should earn extra income 
and profit from its customers.
The advantages of captive insurance companies are as follows:
●
●
Savings may be achieved in overall insurance costs because lower premiums 
are often set by captive insurance companies.

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Insurance and risk transfer 
205
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●
The captive insurance company can gain access to reinsurance markets, 
where premium rates and risk capacity can be favourable.
●
●
By being exposed to the cost of insurance claims, a greater risk awareness
and greater concern about loss control can be achieved.
●
●
Greater insurance cover can be offered by the captive insurance company 
than is available in the commercial market.
●
●
Certain tax benefits may be available from having a captive insurance 
company, although these have reduced in recent times.
The disadvantages of captive insurance companies are as follows:
●
●
The captive will be exposed to insurance claims that would otherwise have 
been paid by the commercial insurance market.
●
●
The parent organization has to allocate capital to ensure adequate solvency 
of the captive insurance company.
●
●
When large losses are paid by the captive, these are consolidated to the parent 
balance sheet and the organization ultimately pays these losses.
●
●
Captives writing business in other territories will probably do so on a
non-admitted basis and this may create compliance difficulties.
●
●
Significant administrative cost, time and effort can be involved in the 
management of the captive by parent head office personnel.
An example of how the advantages of captive insurance companies are viewed is 
provided by the text box below. There is a wide range of suitable domiciles for
captive insurance companies, including Guernsey, Ireland and Malta.
For many years, large corporations have enjoyed many benefits from operating their own 
captive insurance companies. Most were established to provide coverage where insurance 
was unavailable or unreasonably priced. These insurance subsidiaries were often domiciled 
offshore, especially in Bermuda or the Cayman Islands.
The risk management benefits of these captives were primary, but their tax advantages 
were also important. A properly structured and managed captive insurance company can 
provide the following benefits:
●
●
tax deduction for parent company for premium paid to captive;
●
●
opportunity to accumulate funds in a tax-favoured domicile;
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●
distributions to captive owners at favourable income tax rates;
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●
asset protection from the claims of business and personal creditors;
●
●
reduction in insurance premiums paid by the operating company;
●
●
access to the lower-cost reinsurance market; and
●
●
insuring risks that would otherwise be uninsurable.
Benefits of captive insurance companies

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