Recent Developments in the Captive Insurance Industry

Recent Developments in the Captive Insurance IndustryBy Shanique Hall, CIPR Senior Research Analyst• IntroductionCaptives, as an attractive alternative to self-insurance, have long been used by many prominent companies to manage their insurance risks. While the captive concept has existed for centuries, it has gained widespread acceptance only in the past few decades. Today, the captive market is as active as it has ever been, with its benefits now attracting worldwide attention. Captives are widely used both domestically and abroad. A.M. Best estimates that there are more than 5,000 captives worldwide. While Bermuda, the Cayman Islands, Barbados and Guernsey have historically been the most popular domiciles for captive formations, many of the captives formed today are in the United States.  This article provides an overview of the captive market—including the types of captives, popular domiciles and typical risks underwritten—and discusses the recent emergence of captive reinsurers/special purpose vehicles to transfer third-party insurance risk. • Captives DefinedIn its simplest form, a captive is a wholly owned subsidiary created to provide insurance to its non-insurance parent company (or companies). Captives are established to meet the risk-management needs of the owners or members. They are essentially a form of self-insurance whereby the insurer is owned wholly by the insured. Once established, the captive operates like any commercial insurer—i.e., it issues policies, collects premiums and pays claims, but it does not offer insurance to the public—and it is regulated as a captive, rather than as a traditional insurer.The International Association of Insurance Commissioners (IAIS) defines a  captive as “an insurance or reinsurance entity created and owned, directly or indirectly, by one or more industrial, commercial or financial entities, other than an insurance or reinsurance group entity, the purpose of which is to provide insurance or reinsurance cover for risks of the entity or entities to which it belongs, or for entities connected to those entities, and only a small part if any of its risk exposure is related to providing insurance or reinsurance to other parties.”[1]The type of entity forming a captive varies from a major multinational corporation to a nonprofit organization. Captives are held by the vast majority of Fortune 500 companies as an alternative method of risk financing (e.g., Gold Medal Insurance Co. was established by General Mills as a captive  and Allstate was originally set up as a captive by Sears & Roebuck Co.). The industries with the greatest number of captives are finance, real estate, construction and manufacturing. Over the past several years, there has been particular growth in areas such as health care, property development and securitization for life insurers. A corporation that forms a captive will normally organize the captive as a subsidiary. Because few companies are in the business of insurance themselves, most captive parents will hire an outside firm, often an insurance company or captive manager, to manage the captive for them.• Origin of CaptiveTo give a bit of history, the captive concept has been around for a long time. In the early 1500s, ship owners met in the London coffeehouses where they retained, shared and transferred the cost of risk associated with their ships, akin to today’s captives.[2] During the 1700s and 1800s, there were instances of mutual insurance companies being formed by members of a particular industry to provide insurance coverage.[3]The term “captive” was coined in the 1950s by Frederic M. Reiss, a property engineer turned insurance broker in Youngtown, Ohio. Reiss, known as the father of captive insurance, used the term “captive” to describe an insurance company he helped form to provide insurance coverage solely to the parent.  In 1958, Reiss incorporated American Risk Management and began to assist corporations in setting up captives.  During this time, U.S. regulations made it prohibitively expensive to form and operate captives in the United States, leading Reiss to seek out other jurisdictions to allow his captive idea to flourish.  In 1960, Bermuda became an offshore financial center and, in 1962, Reiss set up the first modern-day captive there called International Risk Management Ltd.The captive concept took a while to catch on. It gained momentum in the mid-to-late 1980s during the hard commercial insurance market, when liability coverage was either unavailable or unaffordable for many buyers.[4]  Over the past three decades, there has been significant growth in the captive market. Today, there are more than 5,000 captives that do business around the world in a variety of industries, compared to roughly 1,000 in 1980.[5] Almost 3,000 captives are domiciled in the Caribbean; 1,200 captives are domiciled in Europe and Asia; and more than 1,000 captives are domiciled in the United States.• Type of CaptivesThere are various types

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