1. Q: What is a captive?
A: A captive insurance company is generally defined as an insurance company owned and controlled by its insureds. The captive’s primary purpose is to insure the
risks of its owners. It issues policies, buys reinsurance, pays claims and invests premiums similar to a traditional insurance company.
2. Q: Why should I form a captive?
A: There are many advantages to insuring risks through a captive insurance program as well as disadvantages in terms of risk and commitment. Some commonly cited
advantages include:
• Tailored coverage – the captive can custom-write a policy to fit the needs of its insureds, even when such coverages are unavailable or prohibitively expensive in
the commercial market;
• Pricing stability – stable loss experience results in stable premiums. Since the captive insures only the risks of its owners, broad market conditions that result
in fluctuations to premiums may not affect your captive insurance program;
• Direct access to the reinsurance market – the captive can negotiate directly with the reinsurance market thereby avoiding commissions charged by commercial
carriers;
• Greater control over claims – captive insurance, essentially self-insurance, provides financial incentives to control claims costs through proactive risk
management;
• Accumulation of investment income – the captive receives and invests premium payments until such a time when those funds are needed to pay claims, operating
expenses or dividends; and
• Increased insurance capacity – a successful captive will build surplus over time, which will enable the captive to retain more risks.
3. Q: What types of captives can be formed in most domestic jurisdictions?
A: There are seven common types of captives that can be formed in most US states (and the District of Columbia):
• Pure captives – a captive insuring only the risks of its parent and affiliated companies;
• Association captives – a captive that insures the risks of the member organizations of an association and the affiliated companies of those members;
• Agency captives – a captive that is owned by an insurance agency or brokerage and that only insures risks of policies that are placed by or through the agency or brokerage;
• Branch captives – an alien (i.e., foreign) captive licensed to transact insurance in the District through a business unit with a principal place of business in the District;
• Association captives – a captive that insures risks of members of an association and affiliated companies of those members;
• Rental captives – a captive formed to contract with policyholders or associations to insure the risks of such policyholders or associations;
• Segregated accounts – any type of captive may form one or more segregated accounts to insure risks of participants through the use of “protected cells.” Each segregated account is
capitalized separately, and the assets in the segregated accounts are legally separate from the assets in the other segregated accounts.
4. Q: What types of insurance can captives write?
A: Captives are generally restricted to writing only commercial lines of coverage such as commercial property, auto liability, general liability, professional
liability and employers’ liability. Many captives also insure workers compensation; however, this line must generally be written through a commercially licensed insurer and reinsured by the
captive.
5. Q: What is a risk retention group (RRG)?
A: A risk retention group is a captive insurance company operating under the federal Risk Retention Act, and organized for the primary purpose of insuring
liability risk exposures of its group members. Members of the RRG must be engaged in similar business activities (e.g., doctors seeking medical malpractice insurance).
6. Q: What is a feasibility study?
A: The feasibility study, generally prepared by a consulting actuary, is documentation of how the captive program will operate and is a required element of the
captive application. The study is often the pivotal piece of information used to decide whether or not to proceed with the formation of the captive. The study may include both a written summary of
the business plan and five years’ worth of projected financial results. Those interested in forming a captive will need to accumulate three to five years worth of past premium and claims data as well
as prospective information related to the insurance risks the captive is anticipated to write. The cost of the feasibility studies varies with the complexity of the captive program.
7. Q: What involvement will I have in operating the captive?
A: Many of the day-to-day operations of the captive, including accounting, regulatory compliance and routine claims handling are typically handled by contracted
service providers, including an approved captive manager. However, the ultimate responsibilityfor management rests with the captive’s board of directors. Management must provide direction, coordinate
the work of contracted services providers, ensure that loss control programs are executed and attend board meetings, among other responsibilities. Appropriate management participation is critical to
achieving success in a captive program.
For more details on the feasibility study, see below.
8. Q: What is a captive manager?
A: A captive manager is a contracted service provider that specializes in running the day-to-day operations of captive insurers. The captive manager will often
perform the accounting function, interface with the Risk Finance Bureau on regulatory issues and provide general consulting assistance. A captive manager can also be helpful in steering management
through the captive formation process. Contact us for a list of approved captive managers in your preferred jurisdiction.
9. Q: What services do actuaries perform?
A: An actuary experienced in captive programs can assist in the formation of a captive through preparation of the feasibility study, in determining the appropriate
premium to charge and recommending appropriate reinsurance coverage. The captive must also engage an actuary to perform an annual estimate of the captive’s liability for future claims (i.e.,
reserves).
10. Q: What is a fronting company?
A: A commercially licensed insurance carrier that issues a policy and reinsures all or a substantial part of the risk to another carrier such as a captive.
11. Q: Will my captive have to use a fronting company to issue insurance policies?
A: Certain types of coverage require evidence of insurance from admitted insurers. In addition, some insureds may be required to show evidence of insurance from a
highly rated carrier.
12. Q: What types of investments are captives allowed to use?
A: As part of its business plan we develop with you, the captive will document its investment plan including the proposed types of invested assets to be acquired and
held by the captive. We will review the proposed investment strategy and may approve the plan as submitted or require revisions. Typically, newly formed captives invest very liquid,
conservative investments such as bank instruments (e.g., money market funds and certificates of deposit), tax exempt bonds or municipal bond funds or high cash-value corporate life contracts.
13. Q: Does the captive get to keep its investment income?
A: Yes, the captive retains all of the income earned on its investments and can use that revenue for any purpose. The captive retains the risk of default and
depreciation on its investments as well.
14. Q: Does a captive pay income taxes?
A: Yes and no. A captive insurance company is required to file a federal income tax return but generally is not subject to state income taxes. The federal rules for
taxing captive insurance programs are complex and professional advice is often important for making appropriate tax elections. If these areas are new to your tax or accounting professional, we
can better direct them or make new introductions on your behalf.
15. Q: Can a state guaranty fund assess captives who write business in their state?
A: No. Captives are exempt from state guaranty fund assessments.
16. Q: Where can I find more information on captive insurance?
A: A variety of good information on captives is available on the Web including the following industry association websites (links to follow):
Kentucky Captive Association
Delaware
Utah
South Carolina
Hawaii
Washington, D.C.
Nevada
Vermont
Arizona
Montana
17. Q: What information is required to accompany the captive application?
A: The application must include the following:
• Application checklist
• Business plan summary
• Bylaws, articles of incorporation and participation or shareholder agreements
• Captive manager and other service provider agreements
• Application fee ($500) and certificate fee ($300)
• Detailed plan of operations (feasibility study)
• Biographical affidavits for officers, directors and legal counsel
18. Q: What are the typical capital and surplus requirements for domestic captive jurisdictions?
A: The statutory minimum capital and surplus requirements vary by state, but he figures listed below are good approximations across states. Additional capital
may be required based on the volume and type of risk to be retained. An actuary or captive manager will be helpful in determining an appropriate level of capital to maintain.
Captive Form
Paid-in-capital Surplus
Total
Pure captive
$100,000 $150,000
$400,000
Association captive –
mutual $100,000 $500,000
$600,000
Agency or rental captive
$100,000 $300,000 $400,000
19. Q: What are the common sources of formation capital?
A: Capital, either in the form of cash or an approved letter of credit, is often funded by the owner(s), but may also be obtained through assessments on the
individual insureds.
20. Q: Can I use a letter of credit to capitalize the captive?
A: It depends on the jurisdiciton, some domiciles' Captive Law allows for a letter of credit as evidence of the formation capital. In those cases, a letter of
credit can often satisfy both the minimum capital and surplus requirements.
21. Q: What fees are involved in setting up a captive?
A: Most states charge a non-refundable fee of less than $1,000 which is required with the application and a licensing fee of not more than $500 which is assessed
upon approval of the application. We do not charge any additional fees until it comes time to sign a binding engagement letter (then typically $2,500) if we deem it necessary to send the
feasibility study to an independent actuary for review. The costs of professional services to complete the application, feasibility study and incorporate the entity can vary significantly based on
the type of captive, the nature of the risks and the complexity of the program. In our experience, we have seen organizational costs vary between $50,000 and $75,000.
22. Q: What is underwriting?
A: Underwriting is the process of selecting and rating (i.e., pricing) the risks to insure.
23. Q: What is reinsurance?
A: “Insuring the insurer.” A form of insurance whereby one insurer agrees to indemnify another insurer for losses resulting from retained risks. Reinsurance is very
common in captive programs and can take a variety of forms including:
• Quota share reinsurance – the captive and the reinsurer agree to split premiums and losses proportionally (e.g., 50/50 split);
• Excess of loss – the reinsurer agrees to reimburse the captive for claims costs over a specified amount (e.g., individual claims over $100,000).
24. Q: What is the difference between gross written premium and net written premium?
A: Gross written premium represents the consideration charged to the insured. When the captive shares risk with a reinsurer, part of the gross premium is paid to the
reinsurer. The remaining premium (i.e., gross less reinsurance premium) represents the net written premium.
25. Q: How should I decide what reinsurance programs are appropriate for my captive?
A: It is very important to consult someone experienced in forming captive programs to select an appropriate reinsurance program for your captive. Actuaries and
captive managers may be valuable resources in designing the reinsurance program and
contracting with reinsurers.
26. Q: What are premium taxes?
A: Captive domiciles each charge a tax on the amount of premium written by the captive. The District of Columbia's tax rates can be found at
www.disb.dc.gov.
27. Q: How does a captive settle claims?
A: Claims against captive insurance policies are settled essentially in the same manner as commercial policies. Often, captive programs are structured so that the
fronting carrier settles the claims. In other cases, the captive may settle claims directly or through use of service providers (i.e., insurance adjustment firms and attorneys).
Q. Is a feasibility study the same as an actuarial report?
A. No, a feasibility study is a comprehensive plan that looks at all aspects of the business of starting and operating a casualty insurance company. It includes actuarial analysis,
accounting, financial feasibility proformas, and is quarterbacked by your advisors in conjunction with the captive's administrative manager.
Q. How long does a feasibility study take?
A. Anywhere from as long as six months (for completely new ground/field), to as little as 10 days in a more common situation. Common practice is to allow 30 days for a reasonalbe
study. Five-50 page report, based on complexity.
Q. What are the elements of a feasibility study?
A. 1. Clarify the objective: what is the client trying to accomplish withe a captive?
2. Define the risk: A pre-design of the policy, defining the language and the risk that client wished to cover (required for legal and policy documents).
3. Defining what risks aren't "insurance" (but commonly found in incorrect captive programs): examples: domestic insurance warrantee policy, but warrantees are not considered
"Insurance" in 30 states (including CA); punitive damage policies (go against public policy), i.e. exclusions of use during an illegal activity, drunk driving is a felony, is not allowed, because
negligence is allowed as a claim.
examples allowed: football draft picks in case they get hurt in final year of play.
4. Measuring risk: What is their business, what will they retain, what wil the shift to captive, what are the loss projections? What's the reality of market loss projections vs.
their individual claims history.
5. Expenses: Taxes, jourisdiction fees, consulting expenses, income tax issues (if not 831b), offshore excise taxes (unless declare US Entity), "excess and surplus lines taxes" of
insurance and related taxes.
(Arizona charges no premium tax.)
6. Self-Procurement Taxes: For insuring across state lines, depending on the state.
7. Capitalization: Return on investment (on capitalization), prroforma (income statement and balance sheets) based on claims expectations, risk of having to add additional capital.
8. Structuring strategy: What makes the most sense in your case, a pure captive, RRG, agency captive, etc. Pay a fronting carrier and become a reinsurance company?
9. Domicile Choice: VT = Fortune 500 (higher premium tax, but need more hands-on attention); Bermuda/Barbados (competing for Foturne 500); Utah/Kentucky (single-parent company)
uninsured risks. Like "Forum Shopping" in the legal arena.
10. Operations: Roles, responsibilities for all parties, expectations, timing, how operations will occur (TPA, Admin Manager). Client needs to understand that they need to have
someone manage the captive for them on account of regulatory filings, administrative requirements demand hiring the right people to do the management rather than add their own admin. overhead of
people who are not familiar with management. Usually 4-5% of premiums go toward management. Client it strongly advised not to attempt this with their account, if the demand to do so, they
need to sign over that they are taking responisiblity for managing the captive as a going concern, active, operating insurance company.
Capital Management
Consulting, LLC
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