Uses for a Captive

Just as there are many types of captives, there are many uses for each type captive.  Some of the uses for a Pure captive include:

Premium Recapture

In this scenario, the captive arrangement is used to manage your own risk in-house, by paying premiums into your captive that you were previously paying to an unrelated 3rd party casualty insurance company (AIG, Chubb, Travelers, etc.).  For example, if you have an excellent claims history (or, rather, a lack of claims history) you might choose to replace your catastrophic carrier with your own captive.

Conversely, if you were  unable to find affordable coverage in the marketplace (due to an unusually high claims history which you can tie to non-recurring events), you might use the captive as your insurer of last result.  In either case, you could then acquire high-deductible reinsurance through the captive from an outside casualty insurer to cap your exposure.

Profit Center

In the profit center model, the captive takes in premiums from unrelated parties in exchange for a well-known risk profile and definable exposure.  Examples of this include selling renter's insurance policies (generally $25,000 max) to renters in apartment complexes owned or managed by the shareholders.  An even more common profit-center use for captives is providing extended auto warranty policies through the shareholder's auto dealership or network of dealerships.

Sale of a Business

The seller of a business is often asked to make various representations and warranties as a condition of the sale.  A captive can be used on a one-time basis to allow the seller to self-insure and benefit from the premiums paid to his or her captive, while effectively buying insurance against the reps and warranties made in conjunction with the sale.

New Coverage

A captive can be used to provide coverage for shareholders in areas where they previously did not buy insurance, either because such policies were not commercially available to them, or because the costs were prohibitively expensive.  Now that the premiums stay with the shareholder (via his/her captive), it may make economic sense for a business to insure for various risks that they were taking anyway, and not benefiting from via some of the tax advantaged issues relating to captive ownership.  Examples here might include Directors & Officers coverage, Errors & Omissions insurance, loss of key client or employee, or larger catastrophic policies than were previously being purchased.

Obviously coverages in all of the above scenarios must fit within the guidelines of the IRS definition of insurance.  The policies must include risk shifting and risk distribution and be issued by an appropriately capitalized insurance company, using actuaries to determine fair market prices and terms.