The Basics
The cost and availability of corporate insurance continue to be a major concern of Montana’s business community. Interestingly, many business leaders do not know that Montana took action several years ago to help businesses find a solution to their risk management challenges by allowing them to form and operate captive insurance companies that can insure business risks anywhere in the world.
In this regard, a formal introduction to captive insurance is overdue.
The simplified explanation of captive insurance is that it is a specialized form of self-insurance where a corporate entity or a group of corporate entities form their own insurance company to insure the risks of its parent(s) and affiliated entities.
Only certain states allow the formation of captive insurance companies, and Montana inserted itself into the captive industry as a captive “domicile” in 2001. Since then, the state has licensed more than 500 captive insurance companies, which were formed to cover a variety of corporate risks.
Years ago, most captive insurance companies were formed in offshore locations, such as Bermuda or the Cayman Islands, but the current trend is for captives to be formed in domestic domiciles. Montana is part of this domestic domicile club, which is a tremendous advantage to the state’s business community.
WHY FORM A CAPTIVE
There are many good reasons for business owners to form a captive insurance company – not the least of which is the creation of teamwork among the risk management, treasury, and tax-accounting functions for overall improved financial health. Several more specific reasons are as follows:
THE ALTERNATIVE TO COMMERCIAL INSURANCE
The first apparent benefit of forming a captive is to take control of the risk management budget, now and in the future. Underwriting cycles for first-dollar coverage become non-events for the owner of a captive, and exposures that are difficult to cover in the commercial market are secure in a captive. Captives commonly provide policies covering property, liability, Excess Workers’ Compensation, and medical stop-loss insurance. Life, health, surety, marine, and disability insurance can also be written by a captive insurance company. Montana’s laws have specific regulations on some of these policy types, so be sure to confirm with the captive regulatory staff before choosing your captive-placed policies.
COVERAGE TAILORED TO AN ORGANIZATION'S SPECIFIC NEEDS
Many organizations – to their dismay – experience shifting or evolving risks as their businesses grow or take new directions. Exposures such as environmental risk, employment practices liability, flooding and many other risks can be actuarially quantified and protected in a captive program while others wait for the development of “off the shelf” programs from commercial insurers. The Montana regulatory team prides itself on being flexible in terms of risks chosen to insure and business plans that accommodate the insured operating entity’s plans. We are always willing to listen to new concepts in the insurance market to see if our laws can accommodate such a request.
ACCUMULATION OF INVESTMENT INCOME TO REDUCE NET COSTS
The captive has control over its investment income. As with any insurance company, the captive invests the assets that support loss reserves and capital surplus. Prudent investing can return profits greater than those that would be provided by a commercial insurer and will help immunize the loss portfolio against unexpected inflation.
IMPROVED CASH FLOW
A captive provides a place to store funds for future liabilities without paying for risk transfer. The reserve funds don’t have to be identified for a particular exposure but exist in a pool. This pool of funds can be used to insure any difficult-to-insure exposures without further cost to the insured businesses.
INCENTIVE FOR LOSS CONTROL
It’s amazing how careful people can become if they have to pay for their mistakes. The same holds true among owners of captive insurance companies. They quickly understand the value of things like operational safety programs, careful maintenance, staff training, and peer review, depending on the exposures being covered. It’s no coincidence that captive owners usually see decreased loss experience in the years following captive formation. This results in healthier, more productive, and profitable organizations.
GREATER CONTROL OVER CLAIMS
Claims handling is performed at the direction of the captive owner rather than an insurance company whose best interests are often served by delaying claims (see Hurricane Katrina). Claims review includes all the necessary parameters and standards that the captive owner requires for efficient risk management.
UNDERWRITING AND RETENTION FUNDING FLEXIBILITY
Many large organizations with decentralized operations may experience different appetites for risk and at different levels. For example, a parent organization may be able to maintain higher risk retention than its local operation units can. A captive can be extremely effective in its ability to spread risk according to the needs of the organization.
REDUCED COST OF OPERATION
In short, there is no point in forming a captive that will not reduce overall operating costs. A captive may offer the early recognition of losses for federal income tax purposes. Premiums may be tax deductible if the captive is found by the IRS to be an insurance company by insuring the exposures of those other than its parent. Whether premiums will be deductible when paid needs to be addressed by any corporation that considers forming a captive.
DIRECT ACCESS TO THE REINSURANCE MARKETS
As an insurance company, a captive may purchase a selected level of loss protection from reinsurance companies. Unlike the “primary” insurance market, the reinsurance market is largely unregulated concerning forms, rules and rates. Unique exposures can be handled with customized policy language. Many captive owners are also supplementing their existing commercial policies by either using their captive to reinsure a layer of the commercial policy as an excess layer or as the initial payment layer.