How Do Captives Work?
Captive insurance is increasingly becoming a more popular means to manage risk, especially for middle-market companies. Unlike a risk purchasing group or self-insured pool, a captive is a licensed and regulated insurance company that insures the risks of its owners, policyholder/members, affiliated business or unaffiliated business and organizations, including non-profits. Owners of captives not only put their capital at risk, they also participate in helping control the underwriting, claims and investment decisions of the insurance company. The captive operates similarly to a traditional insurance company and it may either issue policies directly to its insureds or act as a reinsurer to another carrier that will actually issue the policy. The captive assumes premiums and pays claims. It also sets aside reserves to pay any legal obligations as result of its insurance coverage or reinsurance agreements. It pays for its operating expenses and can produce an underwriting profit, which can be shared with owners. Additionally, the captive earns investment income on loss reserves and invested assets.
Generally, all captives have a Board of Directors and are required to undergo insurance examination and audits. The operations are typically outsourced, using a captive manager to perform the day-to-day operations, maintain a set of books and records, and liaison with the board and regulators.
There are many types of captives: Agency Captives, Single Parent (aka “Pure”), Group or Association Captives, Protected Cell Captives (PCC), Reciprocal Captives, Branch Captives and Risk Retention Groups (RRGs).