SilverLink - Winter 2008 - (Page 17)

risk ManageMent Group Captives Captives 101 Basics to Help You Choose Wisely by Adrian Bento SilverLink magazine has presented several articles on the topic of captives. Many people think of the most obvious definition when they hear the word “captive” (something or someone being held or controlled by an outside influence1), and they may not have a good grasp of how the word applies to the insurance industry. The time has come to answer these questions: 1. 2. 3. What exactly is a captive? Why do captives exist? How can captives be accessed by business entities? and this translates into more sensitivity when pricing the exact exposures assumed and more predictability in the underwriting results produced by the captive. • A captive is regulated as an insurance entity in the jurisdiction in which it is incorporated. Most of the jurisdictions that have flourished as captive domiciles (“domicile” means “the location where a captive is formed”) tend to be offshore in such desirable destinations as Bermuda, the Cayman Islands, the Channel Islands, etc. Aside from being in a beautiful part of the world, these areas offer an extremely favorable tax and regulatory environment for the operation of captive organizations. Along with the above-named locations, there are also a number of states in the US that have enacted captive legislation and are successfully attracting new entrants. Most of these, however, including Vermont, the District of Columbia and Hawaii, are relatively new entrants compared to the Caribbean domiciles. At this point, it should be noted that the locations outside of mainland United States have enjoyed a relatively benevolent, hands-off environment. The same may not be true for mainland captives, as the state of Colorado (one of the first states to accept captive insurers) discovered when state regulators had a change of heart regarding the formation of captives. The state of Colorado implemented stringent regulations and removed much of the incentive that was originally offered to potential captives. As a result, at this time, no captives exist in Colorado. What Exactly is a Captive? A captive—at least by the standard, traditional, insurancerelated definition of the term2—is a licensed insurance company wholly owned and controlled by its insureds, with the primary objective of insuring the risk(s) of its owners, and whose owners ultimately share in the profits generated by its underwriting. • Did You Get That? Let’s analyze each component of the definition: 1. A captive is essentially nothing more than a licensed insurance company. The primary feature distinguishing it from a traditional insurance carrier is that the entity is owned by its insureds. The objective is to insure the risk(s) of the captive’s owners. • As a licensed insurance entity, the captive acts in the same way that a traditional insurance company does, in that it underwrites the risks presented to it, issues policies, receives premiums, pays claims, buys reinsurance, provides risk management services, etc. Like a traditional insurance company, a captive can elect to insure one or more of the risks to which an entity is exposed. This is one of the decisions that the owners make when they initiate the captive. By limiting the pool of insurers to these same owners, many of the concerns normally faced by a traditional carrier regarding adverse selection and asymmetry of information are lessened, if not entirely dispelled. This leads to a more homogeneous concentration of insureds whose level of risk is statistically narrower, silverlink — Winter 2008 • 2. 3. • • Owners share in the profits. Like a traditional insurance carrier, a captive also assumes risk, 3 which means that the captive requires risk capital. This capital is typically provided by its owners. The corollary of risk, of course, is reward. In this case, financial reward—in the form of profits generated by the underwriting of the owners’ policies and shared by the owners of the captive. “Ownership and control” means that the owners make all decisions regarding the operation of the captive. The following are types of decisions the owners may make: • 17

Table of Contents Feed for the Digital Edition of SilverLink - Winter 2008

SilverLink - Winter 2008 Contents Risk Management: Where in the World is Human Resource Consulting? Workers’ Compensation Rate Declines Insurance Certificates Haute Retirement It All Began with a Cup of Coffee Playing Fair in the Housing Market Captives 101 Proceed with Caution Fore! (Or is it Pull? or Giddyup?) Don’t Be Fuelish Employee Benefits: Medical Trend Countdown to Compliance Private Client Services: Buy & Sell Agreements Flood Insurance Pushing Wealth to the Next Generation Client Spotlight: Travel and Transport Internal Happenings: SilverStone Group Giving Back Since 1945

SilverLink - Winter 2008

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