The National Association of Insurance Commissioners states that captive insurance is “a form of self-insurance.” Generally, captive insurance provides insurance to its parent company and its affiliates. Although there are certainly risks and challenges associated with captive insurance, it can be an efficient, reliable alternative to traditional insurance. The accurate prediction and management of risk is essential if companies wish to experience the benefits of captive insurance while avoiding potential pitfalls. Actuarial services provide an obvious solution.
What Are the Benefits of Captive Insurance for United States Companies?
As noted by the Washington, D.C. Department of Insurance, Securities and Banking, many of the most recognizable businesses in the United States have formed captive insurance companies. Captives are also popular among other organizations, including non-profits and government entities. Here are some examples of recognizable names that have formed captives:
- General Motors
- Fannie Mae
- Freddie Mac
- Brookfield Properties
- The University of California
- The Port Authority of New York & New Jersey
When considering their options, these organizations and many others were undoubtedly attracted to the benefits of captive insurance – of which there are many:
- Cost efficiency
- Centralization of risk financing
- More personalized coverage for specific risks
- More affordable coverage
- Tax benefits
- Underwriting profits
- Reduced risk exposures
A Brief Explanation of How Captive Insurance Works
The most basic form of self-insurance occurs on a personal scale, and it might involve an individual setting aside a certain amount of money to pay for a potential emergency. Captive insurance takes this same basic concept, but expands it on a corporate level. Instead of setting aside emergency funds in a bank account, a parent company establishes an entirely new subsidiary that provides insurance services back to them. Often, the parent company establishes their captive in a favorable jurisdiction for additional tax benefits. Wisterm guides companies toward these more favorable jurisdictions on a global scale. Popular choices for these “domiciles” include Bermuda, the Cayman Islands, and Luxembourg.
What Kinds of Risk Are Associated With Captive Insurance?
As with any insurance business, there may be numerous risks associated with maintaining a captive insurance company. However, captive insurers may experience heightened risks in certain areas:
- Business interruption
- Professional liability
- Auto liability
- Workers’ compensation
- Employee benefits
- The chance of being underinsured
- Unsustainable distributions to shareholders
The world is to some extent always going to be unpredictable, and certain risks could lead to sudden, serious expenses incurred by the captive insurance company. In worst-case-scenarios, the captive insurance company can even go bankrupt, or “insolvent.” The worst-case-scenarios are likely to involve numerous, simultaneous catastrophic events, but in some instances even a single event can cause excessive financial losses.
How Can Actuarial Services Help Businesses Manage Captive Risk?
Actuaries assess financial risks associated with business ventures such as captive insurance, and they use a range of strategies in order to make accurate predictions. They rely on a keen understanding of mathematics, statistics, and financial theory. Actuarial science is a complex field, and one that Wisterm takes very seriously. Actuarial services can help companies assess risks associated with captive insurance in a number of different ways:
Actuaries Help Set Aside Insurance Reserves
A captive insurance company must hold sufficient reserves on its balance sheet to cover projected costs associated with not only potential claims, but also additional business expenses. Actuaries can help captives calculate the appropriate level of these reserves by projecting future risks with high levels of accuracy. The goal is to achieve balance, with reserve levels that are sustainable, but not excessive. Two relevant calculations may include outstanding loss reserves and bulk provisions for future development on claims.
Actuaries May Carry Out Feasibility Studies To Project Risks
As companies venture into the world of captive insurance, they may enlist the help of actuaries to carry out feasibility studies. These studies may take into account a number of different factors depending on the specific circumstances of each company, including capital levels, coverage needs, and premium costs. This is a markedly different risk assessment technique compared to the average traditional insurer, which tends to project future losses based on broad statistics across entire industries. This means that actuaries can perform risk assessments for captive insurance that are much more tailored than the similar assessments performed within traditional insurance companies, and therefore more accurate.
Actuaries Help Companies Set Viable Premiums
In addition, actuaries can use their risk projection calculations to set viable premium prices. The cost of premiums must accurately reflect the relevant risk, and this is often one of the most challenging aspects of the insurance industry in general. Excessively low premiums lead to net losses for the captive, and by extension the parent company. Excessively high premiums may cause unwelcome attention from tax authorities, which have become increasingly aggressive in their regulation of companies that use captives for potential tax abuse.
There are unique considerations to take into account when controlling and balancing captive premiums compared to traditional insurance. The goal for the captive and the parent company is not necessarily to reduce their respective costs as much as possible, but rather to take into account a number of additional factors – such as security, predictability, and risk tolerance.