Captive insurance companies are now a well established mechanism used by medium to large corporations to finance risk within their organisations in an economic way, as well as these days being used for more esoteric purposes such as insuring third party or related risks, for instance customer insurance.
Paul Bawcutt, in his book Captive Insurance Companies – Establishment, operation and management, cited a definition of a captive as being “a limited-purpose, wholly-owned, insurance subsidiary of an organisation not in the insurance business, which has as its primary function the insuring of some of the exposures and risks of its parent or the parent’s affiliates.” He goes on to qualify this by referring to the various other types of captive, and uses to which they are put, however this definition still holds true for the majority of the 4,000 plus captives operating in the world today.
There are a variety of types of captive apart from the pure or stand-alone vehicle, which only insures its parent’s risks.
Captives can be established by commercial organisations that wish to insure their customers’ risks. For example, high street domestic appliance retailers in the UK have in Gibraltar a captive which underwrites extended warranty insurance for products sold to their customers.The combination of an established customer base, and the low costs of running a captive make this type of operation attractive.
Another variation is group or association captives, where organisations with similar risks in a particular trade combine to form a jointly owned insurer to insure those risks. A good example of this is the many medical malpractice captives in the USA, where groups of doctors combine to insure professional indemnity risks, an expensive insurance in the traditional market in litigation-conscious USA.
Becoming more prevalent in today’s alternative risk financing world are rent-a-captives and cell captives, and in recent years Protected Cell Companies. Their principle is that organisations wishing to benefit from a captive structure, rather than establishing their own vehicle, rent or buy shares in an existing insurer, which has investment and reinsurance facilities already set up. This can be a lower cost option to the traditional stand-alone captive route, and can be tax-efficient. More about PCCs in Gibraltar can be found here.
Most captives start in a relatively small way, selecting certain areas of the parent’s risks to insure, whilst other elements are placed in the traditional insurance or reinsurance markets. The captive’s capacity depends on its capitalisation, and parents are usually conservative when it comes to retention of risk within the captive. The types of risk usually insured “in-house” will be those of a predictable nature, usually high-frequency low-severity risks (such as small liability claims), leaving catastrophic risks, by their nature more volatile and harder to predict, to traditional markets. In this way the captive’s capital (which at the end of the day is group capital) is not overly exposed to uncertain losses.
In all captive insurance structures, the principle motivating factor is a reduction in costs to the parent, or production of additional profit (as in the case of customer-insuring captives). The main area where this is achieved is usually in the expense ratio: captives do not have to advertise or maintain substantial overhead costs of sales staff, branch networks, corporate image and so on. A captive is often managed by a third party manager for a fee, rather than maintaining its own personnel, which reduces not only costs but commitment of management time from the parent. Captives are also often established in offshore domiciles, where statutory regulation is more straightforward than in the major countries.
A specific area where cost savings can be achieved is in the cost of writing the insurances in various territories, especially within Europe. Historically, to write insurance in another country, the captive insurer would in theory have to obtain an insurance company licence in each state where it wished to insure. In practice this was not feasible, and captives, usually based in offshore centres such as Bermuda or Cayman Islands, would use the services of a local insurer in the country where the risk was situated to provide a “fronting” service.
This simply meant that the local insurer would issue policies to the local insured (subsidiary of the parent), then reinsure 100%, or close to it, to the captive. The disadvantage of this is that the fronting insurer will usually charge a facility fee for the service, of as much as 15%, thus increasing the cost of insuring the risk. Arrangement of fronting programmes would also imply an increased administrative load for the risk manager , or the manager of the captive, with associated expense. With the advent of European domiciles such as Gibraltar, and under the European Insurance Directives, business can be written direct on a services basis, without the need for a local licence, and thus avoid that element of cost.
There are other motives for forming a captive:
With all of these issues to be addressed, a flexible domicile is needed from a taxation point of view, as well as one which can provide other advantages.
Gibraltar has the following advantages to a captive owner:
Another string Gibraltar has to its bow is the existence of various Protected Cell Companies, established under legislation passed in 2001, which can provide a ready-made facility for potential captive owners who wish to enjoy the benefits of their own risk finance vehicle, but without the associated costs and management time investment of establishing a stand-alone captive insurance company. PCC cells can also act as an “incubator” until such time as the captive owner decides to take the step of their own corporate entity, and the PCC legislation allows cells to be migrated with relative ease.
All of these benefits can be found in other offshore captive centres – for example insurers in Dublin can write risks in Europe, but costs are high; taxation in Guernsey is zero, however Guernsey insurers are restricted in their ability to write cross-border – the uniqueness of Gibraltar stems from its combining all of the factors into one domicile. That has to give it the competitive edge when formation of a captive or other insurance operation is being considered.
More about Gibraltar as an insurance domicile can be found here