What is a captive insurance company?

A captive insurance company is a licensed insurer owned by the organization, or group of organizations, whose risks it insures. The NAIC describes the classic form as a wholly owned subsidiary that provides insurance to its non-insurance parent. Instead of buying all its cover from commercial insurers, the owner insures part of its own risk through a company it controls, and that company is regulated by the jurisdiction that licenses it, known as its domicile.

How a captive works

The owner's operating companies pay premiums to the captive for agreed coverage, often for a layer of risk they would otherwise retain through deductibles or buy commercially. The captive holds those premiums and its capital, pays claims under its policies, and usually buys reinsurance or excess cover for losses above what it is designed to keep. If claims come in lower than expected, the surplus stays in a company the owner controls; if they come in higher, the owner's capital absorbs the difference. Where a policy has to be issued by an insurer licensed in a particular state, a commercial insurer may issue it and reinsure part of the risk to the captive, an arrangement called fronting.

The results depend on the quality of the loss data, the premium charged, the cost of running the captive and how much risk it keeps. None of those is certain in advance, which is why a feasibility study usually comes first.

Main captive structures

• Single-parent (pure) captive: owned by one company and insuring the risks of that company and its affiliates.
• Group or association captive: owned by several companies, often in the same industry or association, that insure their risks together.
• Risk retention group: a member-owned liability insurer formed under the federal Liability Risk Retention Act.
• Protected cell or rent-a-captive: a business uses a cell or account in a captive owned by a sponsor instead of forming its own insurer.

Each domicile defines its own captive types, and market labels do not always match the statutory ones.

Who runs a captive

A captive has its own board of directors and is usually run day to day by a captive manager under contract. It also relies on an actuary for pricing and reserve opinions, an independent auditor, legal counsel and often a claims administrator. Some domiciles require these roles to be approved or licensed; Vermont, for example, requires an annual audit by an independent CPA and an annual actuarial opinion on loss reserves. The owner remains responsible for governance and for capitalizing the captive as its regulator requires.

Common misconceptions

• A captive is not its captive manager. The owners own the insurer; the manager provides services under contract.
• A captive does not guarantee savings. It keeps risk within the group, so a bad loss year costs the owner.
• Tax treatment depends on the facts of the arrangement and the applicable law. It should not be the reason to form a captive, and it needs specialist advice.
• A captive does not remove the need for commercial insurance. Captive programs commonly combine a retained layer with reinsurance or excess cover.
• Captives are not only for the largest companies. Group, cell and rental structures exist partly so that smaller organizations can share fixed costs; whether any of them fits is a question for a feasibility study.

Where to go next

To evaluate captive options and find providers, see captive insurance. To understand the study that tests whether a captive makes sense, read how to run a captive feasibility study.

Educational information only; not insurance, legal, tax, actuarial or regulatory advice.