The Six Cs of Captive Value: Focus on Commercial
While you’re probably aware of the typical uses for a captive — such as funding the risks of the parent company or its affiliates — on the other end of the spectrum is our last “C,” for commercial. In this scenario, a captive insurance vehicle is used to insure unrelated risk. Acting somewhat like a traditional insurer, captives can participate in third-party insurances offered to customers, vendors, or other related parties, such as extended warranty insurance programs or sub-contractors under an owner-controlled insurance program (OCIP).
Additionally, if the captive performs well, funds from those premiums are kept in the captive, which creates a new profit center for the parent company. It’s important to keep in mind that some underwriting will be needed as, in this case, the captive is attempting to make a profit from these businesses.
Reasons for Forming a Captive Insurance Vehicle — The Six Cs
Many US domiciles allow writing of controlled unaffiliated risks in a captive, but these risks will need to have some form of loss control established to demonstrate to regulators that the captive owner controls these risks to some extent. Captive legislation tends to be more lenient on capitalization over that for traditional insurers, but unrelated onshore risks will still require a bit of scrutiny. Large offshore domiciles are very familiar with captives insuring unrelated risks as well and are very likely to allow a captive to write them as long as there is a strong business plan in place.
For example, XYZ Company’s business involves inspecting and repairing underground storage tanks (USTs). Local regulations require gas stations to insure their USTs to operate but in the commercial market, it’s difficult to insure older USTs and underwriting is quite strict and very costly.
XYZ has excellent loss control practices in place for their clients, including a high level of maintenance and routine inspections, so XYZ decided it would be better off forming its own agency to help other companies insure their USTs after their clients expressed difficulties in purchasing UST insurance.
XYZ Company found that it is difficult to place insurance for older USTs on the commercial market, despite the excellent loss controls they put in place for their clients. They decided to form a captive insurance company to insure these older USTs that the commercial market is reluctant to insure. The captive enables XYZ Company to create a new profit center, which is boosted by the loss controls it put in place, and clients are able to obtain less expensive coverage in a market where it can be difficult to obtain coverage at all.
”Commercial” captives also provide a means to consolidate the risk of non-employed contractors or suppliers through a master insurance program, which is fronted by a commercial insurer. The most common types of programs include:
- Construction wrap-up programs.
- Medical malpractice facilities for non-employed physician groups.
- Auto liability coverage for independent contracted drivers.
- Supply chain liability programs.
Insuring these risks in the captive (minimum 30% of total premium) also creates risk distribution, which supports tax deductibility of captive premiums for the parent company (insured) and may help the captive be recognized as an insurance company for federal tax purposes. Diversification of the captive insurance company’s underwriting portfolio can also be achieved through a pooling mechanism, such as the Green Island Reinsurance Treaty (GIRT), where participating captives “share” their loss experience by transferring a portion of their risk in exchange for assuming a percentage share of the unrelated risks of other treaty participants.
Insuring unrelated risk is one of the many benefits a captive can offer. If you think a captive vehicle would benefit your organization, work with your tax and accounting teams and other advisors to determine the setup that meets the unique needs of your organization.