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In the previous article, we have studied about the concept of captive insurance companies. We have also enumerated the various advantages of using captive insurance companies over traditional insurance companies. However, there was an underlying assumption that all captive insurance companies are the same. That is not the case! There are various types of captive insurance companies in existence.
In this article, we will have a closer look at the different types of captive insurance companies that are present in the marketplace.
Single Parent Captive Companies: These are the most basic level of captive companies there are. As the definition suggests that these insurance companies are fully owned subsidiaries of their parent company. Also, the parent company along with other subsidiaries may be the only clients that a single parent captive company is allowed to have.
The contract between the captive and the parent company is not different from a standard insurance contract. It is just that both the companies actually belong to the same group. This means that there is no real transfer of risk which is taking place. In essence, the parent company is insuring its own risk and using the captive as a shield to obtain many tax advantages.
There are many laws governing the functioning of captive insurance companies as well. In many states, some of these laws do not allow a single parent company to sell insurance to its unrelated affiliates.
For instance, if a steel manufacturing company also has a chain of restaurants, some states will not allow the single parent captive to sell insurance to both. There is a different form of captive company that is allowed to serve both such companies.
The only difference between the affiliate captive and the single parent captive is the number of clients they serve. In all other respects, these companies can be considered to be identical.
The rent-a-captive alternative is usually used by smaller companies. Captive insurance companies offer many benefits. However, there are also a lot of costs to run an insurance company.
Firstly, licenses have to be obtained. Then rules have to be followed regarding how the capital is allocated once premiums are received.
Lastly, a lot of paperwork needs to be done to ensure that the captive company is compliant with the regulations that need to be followed. All of this obviously requires a lot of time and effort and also a lot of money needs to be spent.
This is where the rent-a-captive concept comes in handy. These are basically captive companies that are already in existence and have been created by insurance companies such as AIG, Liberty or Zurich. They take care of all the licensing, procedure and paperwork.
Clients just have to park their money as premium and withdraw it in the form of claims or dividends. Rent-a-captives provide services to multiple clients. However, every client faces only their own exposure. This means that the funds are not really being pooled but instead just being held by rent-a-captive companies.
Group captives are not pure captives. This is because when companies pay their premium into a group captive, they are pooling their funds with others. They are not really insuring only themselves. Instead, they are insuring a lot of other people who may have something in common.
For instance, some group captives provide insurance only to doctors. Others may provide insurance only to ambulance drivers and so on.
In such cases, any group can start a captive insurance company. However, as per law, it is necessary that the group must have been in existence for at least one year. Group insurance companies only accept premiums from members who are also shareholders. If a person is not a shareholder, they cannot be insured by group captives.
The problem with group captives is that people lose money because of the negligence of other members of the group. Hence, if anybody makes a claim, all members of the group have to pay out. In a poorly managed group, people who are prudent about their risk management eventually end up quitting the group.
On the other hand, the ones left in the group are those who would not get insurance anywhere else in the open market. Hence, the problem of adverse selection is built into these captive groups. When people have problems with captive insurance, they are usually referring to captive groups.
Risk retention groups are like captive groups with two important differences.
To sum it up, there are many types of captive insurance companies, and each serves a specific purpose.
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