CAPTIVES

AN OVERVIEW OF CAPTIVE INSURANCE COMPANIES & ALTERNATIVE MARKET STRUCTURES
Foreword
What is a captive insurance company?
Why form a captive?
What risks can be written in a captive?
How is a captive insurance company formed?
What captive domiciles exist?
Why Bermuda as a captive domicile?
What is a captive benefits analysis?

Foreword
For a variety of financial entities, such as Fortune 500 companies, trade associations, governments, professional bodies, insurance agents, etc., captive insurance companies have become an integral part of a successful insurance/reinsurance strategy. Currently, over 50 percent of the total commercial property/casualty insurance premiums paid by U.S. corporations are to alternative risk mechanisms, such as captives, rent-a-captives, Risk Purchasing Groups (RPGs), Risk Retention Groups (RRGs), Segregated Account Companies (SACs) and self-insurance programs (collectively “Captives”).

This overview provides, in broad terms, an understanding of what a Captive is, why and how a Captive is formed, the potential benefits derived from the formation of a Captive and an overview of Bermuda as a Captive domicile.

For organizations that wish to determine the benefits of a captive for their own requirements, we recommend that a Captive Benefits Analysis (CBA) be undertaken. The CBA is a cost-effective and low-risk method to analyze the suitability of a captive for a specific organization, which results in the preparation of a three-year business plan to show how the program is projected to perform.

What is a Captive?
A Captive is an insurance or reinsurance company formed to address the specific insurance needs of its owner. Thus a Captive is a wholly owned (or controlled) company formed primarily to insure the risks of its non-insurance parent or affiliates. Whilst the structure of each captive insurance company tends to be unique, the ownership dictates its allocation into one of the following categories:

Single parent or pure captive
A wholly owned subsidiary created to insure exclusively the risk of its parent and affiliates.
Partial captive
A wholly owned subsidiary that insures both the risks of its parent as well as the risks of others.
Association captive, industry captive, RPG or RRG
A company jointly owned by a number of companies in the same industry that have common insurance needs.
Agency captive
Formed by an Insurance Agency to assume a portion of risk of business written by the Insurance Agency.
Rent-a-captive or Segregated Account Company
A company formed to facilitate the access to a captive environment without the requirement to form a dedicated captive.

Why form a Captive?
Many corporations currently rely on traditional insurance, whereby an insurance premium is paid to a third-party insurer to assume the corporation's risk. Over a period of time, however, an insured may consistently pay premiums that are excessive in relation to its loss experience and risk exposures. In other words, excessive premiums do not come back to the insured; they provide contribution margin to insurance companies.

Many corporations, associations and agencies have recognized that coverage with a traditional insurer is no longer economically viable and have therefore directed their attention to Captives as a means of controlling insurance costs as well as gaining more control over the total risk management process.

A number of captives have been born from the necessity of finding stability in the turbulent insurance cycles, and once formed, most risks have never returned to the traditional markets because of the benefits derived from owning a Captive.

The potential advantages of forming a Captive include:

Reduced Insurance Costs
The premiums charged by a conventional insurer include cost elements, such as acquisition and marketing costs, expense of management and profit margin. Cumulatively these expense factors could add up to 50 percent of a normal insurance premium. Whilst the management of a captive requires certain management costs, the lower overhead costs offer a significant advantage over the traditional insurers.
Profit Potential
Apart from the potential of participating in underwriting profits, there is the opportunity to share in investment income from funds held on premiums and loss reserves, which normally accrues to the traditional insurance company.
Claims Management
Involvement in and control over the claims management process, which could include the selection of counsel for litigation. Elimination of duplication of certain services, such as risk management and loss prevention, performed by traditional insurer, which is currently a fixed element of the premium.
Coverage Availability
There are certain risks for which it is very difficult to obtain adequate coverage at an affordable price. With a Captive it is possible to increase and improve upon the insurance coverages provided by traditional insurers at a reasonable cost and with an acceptable form and wording.
Risk Management
Capability of insurance and risk management to become a profit center and not just an expense plus the promulgation of standard safety policies and procedures.
Tax Considerations
If the Captive is accepted as a genuine insurance company by the parent's country of residence, premiums will be allowed as a tax deduction while tax on the captive's profits can be minimized.
Access to Reinsurance
A Captive has the advantage of direct access to the reinsurance markets and because reinsurers operate with lower acquisition costs, it is possible to afford protection at a lower cost.
Regulatory Environment
The regulatory environment in which Captives operate is generally less restrictive than for traditional insurers and is unencumbered by foreign exchange controls.
Service Providers
The captive domiciles, especially Bermuda, offer an established
infrastructure of accountants, actuaries, bankers, insurance managers and lawyers, etc. to assist in the formation and management of the Captive.

What risks can be written in a Captive?
As long as the Captive insurance company is adequately capitalized and the insurance and reinsurance arrangements are properly structured, there should not be any restriction on the risks that could be assumed.

The following list, which is not exhaustive, details some of the risks written by Captives:

Workers' compensation
General liability (e.g., products liability)
Professional liability (e.g., medical malpractice, architects and engineers [errors and omissions], lawyers and accountants liability, etc.)
Aviation
Property risks (e.g., earthquake, pollution, flood, etc.)
Business interruption, boiler and machinery
Auto risks (e.g., auto liability, auto physical damage, third-party liability for both private and commercial auto)
Financial risks (e.g., surety bonds, credit life, fidelity)
Employee benefits (e.g., health care, group accident and health)
Life and annuities (e.g., long-term business)
Export credit and political risk insurance
Reinsurance of any class

How is a Captive formed?
With the Captive Benefits Analysis (CBA) complete and a decision made to proceed with the Captive formation, there is a well defined process for the formation of Captives in all domiciles. The Bermuda Captive incorporation process requires the preparation and submission of a business plan to the Bermuda government. It is worth noting that one of the cost savings of preparing the CBA is that its analysis forms the basis of the business plan that will be submitted. If a decision is made to proceed, a more detailed analysis of the incorporation process will be provided.

What captive domiciles exist?
There are recognized to be thirty-three (33) non-U.S. captive domiciles including Aruba, Australia, Bahamas, Barbados, Bermuda, British Virgin Islands, Canada British Columbia, Cayman Islands, Denmark, Finland, Germany, Gibraltar, Guernsey, Hong Kong, Ireland, Isle of Man, Jersey, Lichtenstein, Luxembourg, Malaysia, Malta, Netherlands, Netherlands Antilles, New Zealand, Norway, Philippines, Saint Lucia, Singapore, South Africa, Sweden, Switzerland, Turks & Caicos and the United Kingdom.

In addition there are also forty-six (46) U.S. captive domiciles including Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Georgia, Guam, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, U.S. Virgin Islands, Utah and Vermont.

At the present time, the Captives Benefits Analysis (CBA) would evaluate the captive incorporation options that are available in Bermuda and Barbados.

Why Bermuda as a captive domicile?
Beginning in the late 1950s and early 1960s, Bermuda provided a location for the formation and operation of insurance companies that were incorporated, initially, by an Act of Parliament. The development of the Bermuda insurance marketplace resulted in the requirement to create regulatory guidelines, and this led to the enactment of The Bermuda Insurance Act (BIA) of 1978. At the time the BIA was passed into law, there were 700 insurance companies operating in Bermuda. The BIA requires each Bermuda insurance company to prepare accounts (referred to in the BIA as Statutory Financial Statements) in respect of its insurance business for each year, to file annual reports (referred to in this overview as Statutory Financial Returns), to satisfy a minimum liquidity ratio, to satisfy a minimum solvency margin and to appoint a Principal Representative.

The information contained in the Statutory Financial Statements is designed to fulfill the following purposes:

To give as early a warning as possible to any person examining the Statement of any financial or operational difficulties into which the insurer's business has fallen or might appear likely to fall;
To provide the basis on which the Minister of Finance, or any other Bermuda authority, may in good time take action under this Act, or any other statutory provision, to exercise any other statutory power available to him or it for the safeguarding of any element of the public interest involved in or affected by the insurer's business.

As a result of the experience Bermuda has had in managing over 1,300 captives for the past several years, its operating and regulatory environment is flexible in the management of associated issues. The BIA, and the structure of the insurance marketplace that the BIA has fostered, has served to establish Bermuda as the largest Captive and alternative insurance domicile in the world.

Over the years Bermuda has built a very strong and credible reputation for providing the necessary infrastructure of service providers to captives (consisting of audit, actuarial, banking, legal, insurance management and reinsurance, etc.). With the formation of a number of strongly capitalized insurance companies, Bermuda has developed into a "one stop shop" for the insurance and reinsurance requirements (including finite risk products) for companies from the small captive to the Fortune 100 company.

One of the requirements of the BIA is for each insurance company incorporated in Bermuda to appoint an Insurance Manager (who also tends to serve as the Principal Representative). The Insurance Manager assumes the responsibility for the day-to-day management of the captive, which includes the preparation of the financial statements, completion of the audits and the preparation and filing of the statutory financial statements.

What is a Captive Benefits Analysis (CBA)?

Having considered the reasons for forming a captive, an efficient way of evaluating the potential benefits of a captive is to complete a Captive Benefits Analysis (CBA). The CBA requires the gathering of historic premium-and-loss information from which a risk profile is produced and with this information, a business model of how the captive would perform over a three-year period is generated. This business model and potential benefits that could accrue to the captive owner(s) would then be detailed in the CBA.

The costs of and time frame for completing a CBA would be well defined in a written proposal.



	HOME ABOUT CIC CAPTIVES PRODUCTS & SERVICES EXPERIENCE BIO CONTACT 441.293.5970 Capital Investment Company (Bermuda) Ltd. Bermuda Barbados	CAPTIVES AN OVERVIEW OF CAPTIVE INSURANCE COMPANIES & ALTERNATIVE MARKET STRUCTURES Foreword What is a captive insurance company? Why form a captive? What risks can be written in a captive? How is a captive insurance company formed? What captive domiciles exist? Why Bermuda as a captive domicile? What is a captive benefits analysis? Foreword For a variety of financial entities, such as Fortune 500 companies, trade associations, governments, professional bodies, insurance agents, etc., captive insurance companies have become an integral part of a successful insurance/reinsurance strategy. Currently, over 50 percent of the total commercial property/casualty insurance premiums paid by U.S. corporations are to alternative risk mechanisms, such as captives, rent-a-captives, Risk Purchasing Groups (RPGs), Risk Retention Groups (RRGs), Segregated Account Companies (SACs) and self-insurance programs (collectively “Captives”). This overview provides, in broad terms, an understanding of what a Captive is, why and how a Captive is formed, the potential benefits derived from the formation of a Captive and an overview of Bermuda as a Captive domicile. For organizations that wish to determine the benefits of a captive for their own requirements, we recommend that a Captive Benefits Analysis (CBA) be undertaken. The CBA is a cost-effective and low-risk method to analyze the suitability of a captive for a specific organization, which results in the preparation of a three-year business plan to show how the program is projected to perform. Back to Top What is a Captive? A Captive is an insurance or reinsurance company formed to address the specific insurance needs of its owner. Thus a Captive is a wholly owned (or controlled) company formed primarily to insure the risks of its non-insurance parent or affiliates. Whilst the structure of each captive insurance company tends to be unique, the ownership dictates its allocation into one of the following categories: *Single parent or pure captive* A wholly owned subsidiary created to insure exclusively the risk of its parent and affiliates. *Partial captive* A wholly owned subsidiary that insures both the risks of its parent as well as the risks of others. Association captive, industry captive, RPG or RRG A company jointly owned by a number of companies in the same industry that have common insurance needs. *Agency captive* Formed by an Insurance Agency to assume a portion of risk of business written by the Insurance Agency. Rent-a-captive or Segregated Account Company A company formed to facilitate the access to a captive environment without the requirement to form a dedicated captive. Back to Top Why form a Captive? Many corporations currently rely on traditional insurance, whereby an insurance premium is paid to a third-party insurer to assume the corporation's risk. Over a period of time, however, an insured may consistently pay premiums that are excessive in relation to its loss experience and risk exposures. In other words, excessive premiums do not come back to the insured; they provide contribution margin to insurance companies. Many corporations, associations and agencies have recognized that coverage with a traditional insurer is no longer economically viable and have therefore directed their attention to Captives as a means of controlling insurance costs as well as gaining more control over the total risk management process. A number of captives have been born from the necessity of finding stability in the turbulent insurance cycles, and once formed, most risks have never returned to the traditional markets because of the benefits derived from owning a Captive. The potential advantages of forming a Captive include: *Reduced Insurance Costs* The premiums charged by a conventional insurer include cost elements, such as acquisition and marketing costs, expense of management and profit margin. Cumulatively these expense factors could add up to 50 percent of a normal insurance premium. Whilst the management of a captive requires certain management costs, the lower overhead costs offer a significant advantage over the traditional insurers. *Profit Potential* Apart from the potential of participating in underwriting profits, there is the opportunity to share in investment income from funds held on premiums and loss reserves, which normally accrues to the traditional insurance company. *Claims Management* Involvement in and control over the claims management process, which could include the selection of counsel for litigation. Elimination of duplication of certain services, such as risk management and loss prevention, performed by traditional insurer, which is currently a fixed element of the premium. *Coverage Availability* There are certain risks for which it is very difficult to obtain adequate coverage at an affordable price. With a Captive it is possible to increase and improve upon the insurance coverages provided by traditional insurers at a reasonable cost and with an acceptable form and wording. *Risk Management* Capability of insurance and risk management to become a profit center and not just an expense plus the promulgation of standard safety policies and procedures. *Tax Considerations* If the Captive is accepted as a genuine insurance company by the parent's country of residence, premiums will be allowed as a tax deduction while tax on the captive's profits can be minimized. *Access to Reinsurance* A Captive has the advantage of direct access to the reinsurance markets and because reinsurers operate with lower acquisition costs, it is possible to afford protection at a lower cost. *Regulatory Environment* The regulatory environment in which Captives operate is generally less restrictive than for traditional insurers and is unencumbered by foreign exchange controls. *Service Providers* The captive domiciles, especially Bermuda, offer an established infrastructure of accountants, actuaries, bankers, insurance managers and lawyers, etc. to assist in the formation and management of the Captive. Back to Top What risks can be written in a Captive? As long as the Captive insurance company is adequately capitalized and the insurance and reinsurance arrangements are properly structured, there should not be any restriction on the risks that could be assumed. The following list, which is not exhaustive, details some of the risks written by Captives: Workers' compensation General liability (e.g., products liability) Professional liability (e.g., medical malpractice, architects and engineers [errors and omissions], lawyers and accountants liability, etc.) Aviation Property risks (e.g., earthquake, pollution, flood, etc.) Business interruption, boiler and machinery Auto risks (e.g., auto liability, auto physical damage, third-party liability for both private and commercial auto) Financial risks (e.g., surety bonds, credit life, fidelity) Employee benefits (e.g., health care, group accident and health) Life and annuities (e.g., long-term business) Export credit and political risk insurance Reinsurance of any class Back to Top How is a Captive formed? With the Captive Benefits Analysis (CBA) complete and a decision made to proceed with the Captive formation, there is a well defined process for the formation of Captives in all domiciles. The Bermuda Captive incorporation process requires the preparation and submission of a business plan to the Bermuda government. It is worth noting that one of the cost savings of preparing the CBA is that its analysis forms the basis of the business plan that will be submitted. If a decision is made to proceed, a more detailed analysis of the incorporation process will be provided. Back to Top What captive domiciles exist? There are recognized to be thirty-three (33) non-U.S. captive domiciles including Aruba, Australia, Bahamas, Barbados, Bermuda, British Virgin Islands, Canada British Columbia, Cayman Islands, Denmark, Finland, Germany, Gibraltar, Guernsey, Hong Kong, Ireland, Isle of Man, Jersey, Lichtenstein, Luxembourg, Malaysia, Malta, Netherlands, Netherlands Antilles, New Zealand, Norway, Philippines, Saint Lucia, Singapore, South Africa, Sweden, Switzerland, Turks & Caicos and the United Kingdom. In addition there are also forty-six (46) U.S. captive domiciles including Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Georgia, Guam, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, U.S. Virgin Islands, Utah and Vermont. At the present time, the Captives Benefits Analysis (CBA) would evaluate the captive incorporation options that are available in Bermuda and Barbados. Back to Top Why Bermuda as a captive domicile? Beginning in the late 1950s and early 1960s, Bermuda provided a location for the formation and operation of insurance companies that were incorporated, initially, by an Act of Parliament. The development of the Bermuda insurance marketplace resulted in the requirement to create regulatory guidelines, and this led to the enactment of The Bermuda Insurance Act (BIA) of 1978. At the time the BIA was passed into law, there were 700 insurance companies operating in Bermuda. The BIA requires each Bermuda insurance company to prepare accounts (referred to in the BIA as Statutory Financial Statements) in respect of its insurance business for each year, to file annual reports (referred to in this overview as Statutory Financial Returns), to satisfy a minimum liquidity ratio, to satisfy a minimum solvency margin and to appoint a Principal Representative. The information contained in the Statutory Financial Statements is designed to fulfill the following purposes: To give as early a warning as possible to any person examining the Statement of any financial or operational difficulties into which the insurer's business has fallen or might appear likely to fall; To provide the basis on which the Minister of Finance, or any other Bermuda authority, may in good time take action under this Act, or any other statutory provision, to exercise any other statutory power available to him or it for the safeguarding of any element of the public interest involved in or affected by the insurer's business. As a result of the experience Bermuda has had in managing over 1,300 captives for the past several years, its operating and regulatory environment is flexible in the management of associated issues. The BIA, and the structure of the insurance marketplace that the BIA has fostered, has served to establish Bermuda as the largest Captive and alternative insurance domicile in the world. Over the years Bermuda has built a very strong and credible reputation for providing the necessary infrastructure of service providers to captives (consisting of audit, actuarial, banking, legal, insurance management and reinsurance, etc.). With the formation of a number of strongly capitalized insurance companies, Bermuda has developed into a "one stop shop" for the insurance and reinsurance requirements (including finite risk products) for companies from the small captive to the Fortune 100 company. One of the requirements of the BIA is for each insurance company incorporated in Bermuda to appoint an Insurance Manager (who also tends to serve as the Principal Representative). The Insurance Manager assumes the responsibility for the day-to-day management of the captive, which includes the preparation of the financial statements, completion of the audits and the preparation and filing of the statutory financial statements. Back to Top What is a Captive Benefits Analysis (CBA)? Having considered the reasons for forming a captive, an efficient way of evaluating the potential benefits of a captive is to complete a Captive Benefits Analysis (CBA). The CBA requires the gathering of historic premium-and-loss information from which a risk profile is produced and with this information, a business model of how the captive would perform over a three-year period is generated. This business model and potential benefits that could accrue to the captive owner(s) would then be detailed in the CBA. The costs of and time frame for completing a CBA would be well defined in a written proposal. Back to Top