What Is Captive Insurance?
A captive is a licensed insurance company fully owned and controlled by its insureds – a type of “self-insurance.” Instead of paying to use a commercial insurer’s money, the owner invests their own capital and resources, assuming a portion of the risk. The balance is assumed by another insurance company known as a “reinsurance” company. This can mean higher risk when large claims occur, however, it can also save premiums for small claims because the company retains the money otherwise paid to traditional insurers. States have legal protections for captive insurers. They are also subject to licensing and other regulations in their primary jurisdiction. For example, a captive must be able to pay claims and maintain a minimum surplus to avoid financial failure. Because of this, most captives are offshore in countries like Gibraltar, the British Virgin Islands, Mauritius, Qatar Financial Centre, Dubai International Finance Centre, Jersey, and the Cayman Islands.
Some captive insurance policies are fully deductible as a business expense. For example, if you own a medical practice, medical malpractice insurance is a deductible business expense, and the premiums are fully tax-deductible under Sec. 162 of the Internal Revenue Code. Once the premiums are paid, however, the money is lost because the insurer has transferred responsibility for the risks to a third party. If a practice is completely claim-free, it cannot recoup cash paid for the coverage.
The investment committee of a captive insurance policy is also crucial in the early stage of the company’s development. Because the funds will be received almost immediately, it is important that the money is invested wisely. The investment committee is an important source of revenue for the captive. The earnings from investment decisions can be large over time. However, mismanagement can cost a company a significant amount of money. It can also damage the parent company’s financial health.
A successful compliant captive serves a wide variety of businesses. Some include large professional practices, manufacturing companies, and distribution firms. One example is a nursing home in Brooklyn, New York, which suffered a fire that was caused by a patient lighting a cigarette in his room. The sprinklers flooded the entire building. In the event of a loss, the commercial insurer would cover everything except for the front lobby. But the captive insurance policy covered the entire loss.
A captive insurance policy is an excellent defensive strategy for many organizations. The cost of an insurance policy is significantly less than the cost of a self-insured policy. A captive’s financial strength can be boosted by investing in third-party businesses. Additionally, a captive’s financial strength is often higher than that of its parent company. Whether the risk is limited by the product liability of its products or a legal liability, the company must be able to pay for it.
A captive may be useful in times of economic turmoil, where a company may be forced to close due to financial loss. It might be useful in cases of a corporate collapse or a natural disaster. But captive insurance is a separate company from its primary operating business. Hence, it requires special attention and management. Its operations must be transparent and it should be able to pay claims. A business owner should be able to keep track of all its assets and liabilities.