Arm 56 - Chapter 7

Front 1

Single Parent (Pure) Captive Plan

Back 1

Owned by one company that insures all or part of the loss exposures of that company.

Also a hybrid financing plan

Front 2

Group Captive

Back 2

Owned by a group of companies similar to a pool.

Owners under a group captive exercise significantly more control over the management of the company.

If each member retains a portion then transfers the balance this is a hybrid plan.

If the members share all of their losses, this is a transfer plan.

Association captive is a group captive sponsored by an association

Front 3

Risk retention group

Back 3

All owners must be insured by the group.

Only needs to be licensed in one state.

Formed by the US risk retention act of 1986

Front 4

Agency captive

Back 4

Owned by insurance agents or brokers

Front 5

Rent a Captive

Back 5

Rents capital from a captive insurer, which is pays premiums, receives reimbursements, underwriting profits and investment income.
Each insured keeps its own premium and loss account, so no risk shifting or distribution occurs.

Front 6

Protected Cell Company (PCC)

Back 6

Group captive in which each member pays premiums, receives reimbursements, underwriting profits and investment incomes. But with a PCC each member is assured that other members will be able to access capital or surplus in the even other members become insolvent. Each participant is also assured that third party creditors cannot access its assests

Front 7

Captive insurer purpose

Back 7

Is a subsidiary formed to insure the loss exposures of its parent company and the parent's affiliates

To reduce the cost of risk for the parent.

A captive insurer collects premiums, issues policies, and pays covered losses

Front 8

Retaining and transferring losses

Back 8

Captive insurers often retain losses up to a certain point and then transfer the losses beyond that point

Front 9

Combining a captive insurance plan with transfer and hybrid risk financing plans

Back 9

Captive plans are used for the first layer of losses where there is a relatively high loss frequency and low/medium severity.

Transfer plans are used for high severity losses.

Characteristics of a captive plan normally involved both retention and transfer.

Captive plans usually have high administrative costs.

Front 10

Advantages of a captive insurance plan

Back 10

Reducing the cost of risk

Benefiting from cash flow

Obtaining insurance not otherwise available

Having direct access to reinsurers

Negotiating with insurers

Centralizing loss retention

Obtaining potential cash flow advantages in income tax

Controlling losses

Obtaining rate equity

Front 11

Reducing the cost of risk

Back 11

Reduces cost of risk over the long run compared to guaranteed cost because it involves retention

Front 12

Benefiting from cash flow

Back 12

A captive insurer allows the insured to benefit from the cash flow available on losses that are paid out over time because, as a funded plan, the captive earns investment income on premium funds that have not yet been paid out for claims.

Incurred vs paid out. Primary insurance gets cash flow benefits on incurred losses, captive doesnt.

Front 13

Obtaining Insurance not otherwise available

Back 13

The parent organization can obtain insurance coverage that is not available from commercial insurers such as environmental, products, and professional loss exposures.

Front 14

Having Direct Access to reinsurer

Back 14

A captive provides the insured with direct access to the international market of reinsurers which can be more flexible than insurers in terms of underwriting and rating.

The insured also saves on substantial markup costs.

Front 15

Negotiating with insurers

Back 15

The existence of a captive insurer can improve an insured's negotiating power with commercial insurers.

Front 16

Centralizing loss retention

Back 16

The insured can use the captive insurance plan to centralize retained losses that are spread throughout its subsidiaries. Centralization can result in savings to the insured organization because of the lower long-term cost of retention

Front 17

Obtaining potential cash flow advantages on income taxes

Back 17

Generally, a parent company may deduct from its taxes only the associated losses and other expenses that are paid by its captive insurer

The IRS determination of whether premiums paid to a captive insurer are tax-deductible is based primarily on two factors: risk shifting and risk distribution

Front 18

Risk shifting

Back 18

Transfer of risk of loss to an insurer

Front 19

Risk distribution

Back 19

Sharing of risk by an insurer among its insureds

Front 20

Controlling losses

Back 20

Because a captive insurance plan involves retention an insured organization that controls its losses is able to save payments for losses and loss expenses.

Front 21

Obtaining rate equity

Back 21

If the predicted losses are substantially lower than the premium being charged by its insurer, the risk manager often concludes that the insureds premium is a result of the poor loss histories of other organizations with which its pooled.

Front 22

Disadvantages of a captive insurance plan

Back 22

Capital requirements and start up costs

Sensitivity to losses

Pressure from parent company management

Payment of premium taxes and residual market loadings

Front 23

Capital and startup costs

Back 23

A captive insurance plan involves a commitment of capital and start up costs not incurred with other risk financing plans.

Capital must be committed for sever years

Front 24

Sensitivity to losses

Back 24

If the losses retained are higher than forecasted and exceed allocated funds, the financial solvency of the captive could be threatened

Especially relevant when the parent uses a group captive plan.

Front 25

Pressure from parent company management

Back 25

Captive insurers must insure the risks required by their parents.

The reinsurer of the captive will likely be sensitive to overt pressure from t he parent's management that may cause the captive's underwriting standards to be too lenient, its premiums too low, its claims payments too generous, or the lack of cooperation from the parent too easily ignored.

Front 26

Premium taxes and residual market loadings

Back 26

The loss retained by a captive insurer are paid for by the parent company as a premium on which premium taxes and residual market loadings are levied.

Front 27

Conducting a feasibility study

Back 27

An effective feasibility study should focus on an organization's goals for the captive insurance plan. This allows the organization to optimize the plan's design.

The study should also include:

Income statement and balance sheet

At least five years of projected pro forma financial results

An accounting of the effects of all types of taxation

At least one scenario that portrays worse than expected financial results

A detailed explanation of each assumption such as expected loss ratio, interest rates, and year to year growth rates

A model showing the minimum number of participants, premiums and capital

Front 28

Operating as a reinsurer or a direct writing captive insurer

Back 28

To save time and expense of obtaining proper insurance licenses, captive insurers usually operate as a reinsurer behind US licensed insurers acting a a fronting company.

A major advantage of operating as a direct writing captive insurer is that a captive can save the fees charged by the fronting company, which range from 5% to 30% of the premium

Front 29

Fronting company

Back 29

A licensed insurer that issues an insurance policy and reinsures the loss back to a captive insurer owned by the insured organization

Front 30

Direct writing company

Back 30

A captive insurer that issues policies directly to its parent and affiliates and does not use a fronting company

Front 31

Selecting lines of business

Back 31

Captive insurance plans are commonly used to cover lines of business that offer substantial cash flow.

A captive insurance plan allows the insured to benefit from the cash flow available on losses that are paid out over time because the captive earns investment income on premium funds that have not yet been paid out for claims.

Front 32

Setting premium arrangement

Back 32

The premium arrangement because parent and captive can be guaranteed cost or retrospective rated basis.

Under guaranteed cost, the insured pays a fixed premium rate, transferring the entire loss exposure to its captive.

Under retrospective rated basis, the premium rate adjusts based on a portion of the insured's covered losses during the policy period. In this case the insured and captive share the loss exposure.

Front 33

Determining captive domicile

Back 33

Many jurisdictions encourage captive insurers to locate within their territories by offering favorable regulations and imposing few or no taxes.

Although a captive insurer can be domiciled anywhere, an organization usually places its captive insurer within a favorable jurisdiction for the formation and operation of captives.

Front 34

Factors for domiciled captive insurers

Back 34

Minimum premium requirements

Minimum capitalization

Solvency requirements

Incorporation and registration expenses

Local taxes

Types of insurance that can be written

General regulatory environment

Investment restrictions

Ease and reliability of communications and travel to and from the domicile

Political stability

Support infrastructure in terms of captive managers, claim administrators, bankers, accountants, lawyers, actuaries, and other services.