Captive Insurance - Offshore Protection

One of the hottest topic in board rooms today is whether or not to climb onto the captive insurance bandwagon, or if they are already participating, whether they should really venture into underwriting.

Captives now number over 10,000. Many of these captives are located in Bermuda, Bahamas, British Virgin Islands, Cayman Islands, Guernsey, and the Netherlands Antilles. Several billion dollars in premiums flowed through Bermuda based companies last year alone. Of the U.S. Fortune 500 companies, over half have captives.

What is a Captive Insurance Company?

A captive insurance company is a company whose charter permits it to offer insurance to its parent or sister subsidiaries in return for premiums. Usually, this company is located offshore for tax reasons.

Why Start One?

In almost every case, captives are started because of a general dissatisfaction with existing insurance coverage or costs. The advantages are in these areas: Insurance, Commercial, Financial, and Tax.

Insurance

A captive can provide insurance for risks which may not be normally insurable. For example, there is limited insurance available in the areas of strikes, product recall, patent suits, etc. Loss experience is based on the company's experience rather than being averaged with others that have less stringent controls and are therefore more prone to claims. Reduction of insurance costs is available as there is no sales force, claims administration group or other overhead to pay for. Insurance company direct costs can run up to 50% compared to around 5% for captives. Insurance income is earned on premiums because ceding commissions from reinsurance companies, inure to the captive rather than to an outside insurance company.

Commercial

The prime advantage is the ability to earn interest on capital and reserves, thus turning a cost centre into a profit centre. The development of insurance to enhance product acceptability via insurance at the “prenatal” development stage is a good example of this. The ability to be more flexible in the settlement of claims is possible; i.e., perhaps a company would wish to make a commercial judgment on a claim where an advisor or wholesaler might be held to be either more or less liable, as the case may be under ordinary insurance proceedings. The ability to benefit from situations where evidence of insurance is more acceptable than a company guarantee or promise to pay; i.e., sick leave insurance for employees where a union wants a policy of state benefits.

Financial

Captives provide the opportunity for converting specific reserves to insurance costs at the parent level thus converting posttax reserves to pretax expenses. Examples of this could be for building reserves for potential product liability or a subsidiary’s potential debt, or for providing guarantees, etc. The ability to lower costs derived from the realistic evaluation of exposure vis-à-vis existing premium/risk expenses is available. The ability to transfer normally nonconvertible funds for exchange control purposes to a subsidiary as a genuine risk financing measure is generally available. The improvement of cash flow is available using a Captive as in the case of claims where the Captive has use of funds until the claim is settled. In the case of reinsurance, premiums are paid quarterly in arrears instead of yearly in advance as for normal insurance. Premium expense is generally deductible at the parent level, but income earned on investment at the captive level is not taxable. Special rules apply for U.S. and Canadian companies. The lack of regulation of investments at the Captive level mean funds could, with prudence, be used to finance the needs of sister companies.

Tax

Premiums paid to a captive are generally deductible at the parent level (U.S. and Canadian companies require special planning, but remember the tax advantages are merely a bonus to the whole Captive idea). Capital, reserves, and premiums are not taxed in most offshore locations. The success of a Captive relies on good management not good luck. Top management must understand the long-term commitment to captive insurance. Bad risk assessment or a series of unlucky occurrences can cost a Captive dearly in the early years. Annual premium costs alone are not a sufficient criteria for establishing a Captive. Most importantly, a company needs a good spread of risks and a low maximum loss potential.

Banking Advantages

Captive reserves may be invested in the money markets. Loans may be made to provide funding capital for the Captive. Loans can be made to provide premiums which have to be paid in advance. Loans for claims payments may be made where assets are temporarily not available in the Captive or the Captive is involved in legal action. New banking relationships are available with the Captive and new business can be obtained. Access to reinsurance companies as possible clients may become possible and added service may be offered to existing clients. Possible foreign exchange dealings are feasible; e.g., premiums, claims, or reinsurance. Security custodianship of investment is available.

What We Can Provide

• We can assist in the formation of a captive insurance company and the acquisition of the insurance licence. There are a number of popular jurisdictions where there is possible and the fees and process is similar to the acquisition of banking licence. See offshore bank formation - the same table there that provides a comparison of costs by jurisdiction also applies to insurance company, with only difference that where applicable the capitalization requirements and licence fees are usually closer to the cost of a Class B or restrictive bank licence (but not always).
  
  
• Experienced management and accounting staff for all records keeping aspects.
  
  
• Investment management capabilities on an international basis.
  
  
• Consulting on captive formation and structure vis-à-vis parent.
  
  
• Access to risk managers and consultants where necessary.