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If your client cannot find an insurance company to insure it against particular business risks, you may want to explore captive insurance.  A captive insurance company is a wholly owned subsidiary insurer formed to provide risk mitigation services for its parent company or related entities. Many businesses begin with coverages such as the deductible or self-insured portions of general liability, auto, casualty, property and workers compensation losses, but often expand coverages to include unique risks such as management liability, environmental liability, terrorism, cyber, professional liability, and extended warranty claims. Risks can be first-party or third-party, and companies can be creative in how they utilize their captive programs. Deiter T. Ludwig, Vice President of Marsh Captive Solutions, Marsh Management Services, Inc., and Ryan M. Mihalic, Esquire, Director and Assistant General Counsel of CareFirst Blue Cross Blue Shield, discussed captive insurance in Maximizing the Value of Captive Insurance, a program presented during the MSBA’s Legal Excellence Week.

Why form a captive insurance company?

Many captive insurance structures offer better (or more affordable) coverage for the parent company’s specific risks.  Usually, the insurance provided is more affordable, and there may be tax savings as well as control of administrative costs.  Of course, if your client simply cannot find an insurer to protect it against its business risks, then captive insurance is something you should explore and recommend to the decision-makers. A captive insurance company can also fill holes in existing policies or provide coverage not otherwise available in the external market.  Risks like cyber-security continue to grow and increase premiums, which highlights the need for robust coverage.  Your client may leverage the captive to provide additional lines of coverage for new and existing customers.    

Captives can be domiciled and licensed in a wide number of jurisdictions, both in the U.S. and offshore. The captive’s primary jurisdiction is known as its “domicile.” Currently, Vermont, Utah, Delaware, North Carolina, and Hawaii round out the top five highest number of captives by U.S. domicile.  However, key factors to consider before selecting a domicile include regulations, infrastructure to support the captive (experts who understand captive industry), permitted businesses,, and convenience (requirements to hold board meetings in the state of domicile). 

Key steps in the process to determine if captive insurance is feasible for your client

Conducting a basic company diagnostic and potential opportunities is a good first step.  Analyze the operational and financial advantages with key employees, including the chief financial officer and tax experts.  As part of the feasibility study, consider mitigation in gaps in your available coverages, increased coverage for cyber security risk, and access to global reinsurance markets and federal programs providing coverage for cyber and terrorism. Outline a captive structure and select potential domiciles for the company.  Determine whether your client is a good candidate for captive insurance with the decision-makers and experts.  

Types of Captives

There are many different types of captive insurance companies.  A single-parent captive is wholly owned and controlled by one company.  A protected cell captive is formed by a third-party sponsor who “rents” cells to outside companies.  The liabilities and assets of each cell are separate from other cells.  A cell may be incorporated for federal tax purposes. This is a low-cost alternative to a wholly owned captive.  A risk retention group is permitted per federal legislation known as the “The Risk Retention Act.”  The group may only write liability lines of coverage on a direct basis to its participants.  The group may also operate in all fifty states but only licensed in its state of domicile.  A group captive is owned and controlled by multiple companies to insure or reinsure the risk of the group.  Typically, each participant has an individual layer of participants’ risks.  This can be less costly than retail insurance.  The group benefits from good loss performance, and there is also peer accountability for loss control. This list is not exhaustive, and consideration should be given to more sophisticated or innovative ways to take advantage of captives.  The variety of captives provides options for each company’s needs and strategic plans and supports a company’s ability to finance its risk in a way that is conducive to its unique dynamics and structure. 

Summary.  A captive insurance company is an insurance company that is wholly owned and controlled by its insurers, with a primary purpose to insure the excess financial and business risks of its owners in addition to, or as supplement of, market-based insurance coverage. The potential benefits of having a captive insurance company include lower insurance costs, tax advantages, underwriting profits, and greater control over coverage. Captive insurance companies can be helpful when the commercial insurance market is unable or unwilling to provide coverage for certain risks. Pros and Cons include overhead expenses, compliance issues, and the potential to be underinsured. Most Fortune 500 companies today have captive insurance companies and this type of insurance should be considered if your client is looking to insure a wide range of risks.

This course is available on-demand to MSBA members (complimentary) and non-members ($59). To download, click here.