Captive Insurance Glossary

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ALIEN - An insurer domiciled outside the United States.

ALTERNATIVE MARKETS - Mechanisms used to fund self-insurance. This includes captives, which are insurers owned by one or more non-insurers to provide owners with coverage. Risk-retention groups, formed by members of similar professions or businesses to obtain liability insurance, are also a form of self-insurance.

ASSOCIATION CAPTIVE INSURANCE COMPANY - Any company that insures risks of the member organizations of the association, and their affiliated companies.

BRANCH CAPTIVE - Is a unit of an existing offshore (alien) captive, currently licensed to write employee benefit business for its owners and affiliates onshore. The branch is regulated as a pure captive, is taxed only on the branch writings and is required to use an onshore trust for the protection of US policyholders and ceding insurers.

BINDER - A record of reinsurance coverage pending replacement by a formal reinsurance contract, usually a facultative certificate.

BORDEREAU - A report provided periodically by the reinsured detailing the reinsurance premiums and/or reinsurance losses with respect to specific risks ceded under the reinsurance agreement.

CAPACITY - The supply of insurance available to meet demand. Capacity depends on the industry’s financial ability to accept risk. For an individual insurer, the maximum amount of risk it can underwrite based on its financial condition. The adequacy of an insurer’s capital relative to its exposure to loss is an important measure of solvency. A property/casualty insurer must maintain a certain level of capital and policyholder surplus to underwrite risks. This capital is known as capacity. When the industry is hit by high losses, such as after the World Trade Center terrorist attack, capacity is diminished. It can be restored by increases in net income, favorable investment returns, reinsuring more risk and or raising additional capital. When there is excess capacity, usually because of a high return on investments, premiums tend to decline as insurers compete for market share. As premiums decline, underwriting losses are likely to grow, reducing capacity and causing insurers to raise rates and tighten conditions and limits in an effort to increase profitability. Policyholder surplus is sometimes used as a measure of capacity.

CAPITAL - Shareholder’s equity (for publicly-traded insurance companies) and retained earnings (for mutual insurance companies). There is no general measure of capital adequacy for property/casualty insurers. Capital adequacy is linked to the riskiness of an insurer’s business. A company underwriting medical device manufacturers needs a larger cushion of capital than a company writing Main Street business, for example. (See Risk-based capital; Surplus; Solvency).

CAPTIVE INSURANCE COMPANY - Any pure captive insurance company, association captive insurance company, or industrial insured captive insurance company formed or licensed under the provisions of this chapter. A company which is wholly-owned by another organization (generally non-insurance), the main purpose of which is to insure the risks of the parent organization.

CEDE - To transfer to a reinsurer all or part of the insurance or reinsurance risk written by a ceding company.

CEDING COMPANY (Also Cedent, Reinsured, Reassured) - The insurer which cedes all or part of the insurance or reinsurance risk it has written to another insurer/reinsurer.

CESSION - The amount of insurance risk transferred to the reinsurer by the ceding company.

COMMUTATION - In the event of the termination of this contract, the Reinsurer shall be released from all further liability to the company for all loss and allocated loss expense not finally settled by the company as of the date of termination. In consideration of that release, the Reinsurer shall pay to the Company all amounts of loss and allocated loss expense due for losses finally settled.

EVERGREEN LETTER OF CREDIT - Letter of credit with an initial expiration date but containing a clause that states that it will be automatically extended for additional periods unless the issuing bank provides notice to the beneficiary stating otherwise.

FACULATIVE REINSURANCE - A reinsurance policy that provides an insurer with coverage for specific individual risks that are unusual or so large that they aren’t covered in the insurance company's reinsurance treaties. This can include policies for jumbo jets or oil rigs. Reinsurers have no obligation to take on facultative reinsurance, but can assess each risk individually. By contrast, under treaty reinsurance, the reinsurer agrees to assume a certain percentage of entire classes of business, such as various kinds of auto, up to preset limits.

FEDERAL RISK RETENTION ACT - Preempts some state functions. For example, the act does not allow a state insurance regulator to prohibit risk retention groups domiciled in other states from operating within the regulator's state, thus eliminating the need for a fronting company.

FRONTING - A procedure in which a primary insurer acts as the insurer of record by issuing a policy, but then passes the entire risk to a reinsurer in exchange for a commission. Often, the fronting insurer is licensed to do business in a state or country where the risk is located, but the reinsurer is not. The reinsurer in this scenario is often a captive or an independent insurance company that cannot sell insurance directly in a particular country.

INDUSTRIAL INSURED - An insured which procures the insurance of any risk or risks by use of the services of a full-time employee acting as an insurance manager or buyer and whose aggregate annual premiums for insurance on all risks total at least $25,000 and who has at least 25 full-time employees.

INDUSTRIAL INSURED CAPTIVE INSURANCE COMPANY- Any company that insures risks of the industrial insureds that comprise the industrial insured group, and their affiliated companies.

INSOLVENCY CLAUSE - A contractual provision, generally required by statute or regulation as a prerequisite to receiving credit for reinsurance, under which the reinsurer agrees, in the event of the ceding insurer's insolvency, to pay its reinsurance obligations under the contract whether or not the insurer has paid its obligations.

LAW OF LARGE NUMBERS - The theory of probability on which the business of insurance is based. Simply put, this mathematical premise says that the larger the group of units insured, such as sport-utility vehicles, the more accurate the predictions of loss will be.

LETTER OF CREDIT(LOC) - Undertaking, usually on the part of a bank and at the request of one of the bank’s customers, to pay a named beneficiary a specified amount of money (or to deliver an item of value) if the beneficiary presents documents in accordance with the terms and conditions specified in the letter of credit. A LOC, within the context of reinsurance, is a banking instrument established on a "standby" basis to secure recoverables from non-admitted reinsurers to enable the ceding company to reduce the provision for unauthorized reinsurance in its statutory statement.

LOSS PORTFOLIO TRANSFER - Is retrospective in nature, as they involve the transfer of incurred losses. Such programs can utilize reserve discounting – on either a structured or an unstructured basis, and/or they can have adjustment provisions to take into account any future reserve deterioration.

NON-ADMITTED INSURERS - Insurance companies not licensed in a state may engage in business in the state if an admitted, properly filed company issues the policy and reinsures losses to the non-admitted reinsurer.

NON-SUBSCRIBER WORKERS' COMPENSATION PLAN - A non-subscriber is an employee who elects, by filing appropriate notices required by state insurance authorities, to pay work-related injury loss through some method other than statutory workers' compensation. Three states – Texas, South Carolina, and New Jersey – allow such an election.

PARTICIPANT - The insured whose risks are underwritten by a sponsored captive.

POOL - Any joint underwriting operation of insurance or reinsurance in which the participants assume a predetermined and fixed interest in all business written.

PRIMARY - In reinsurance this term is applied to the nouns: insurer, insured, policy and insurance and means respectively: (1) the insurance company which initially originates the business, i.e., the ceding company; (2) the policyholder insured by the primary insurer; (3) the initial policy issued by the primary insurer to the primary insured; (4) the insurance covered under the primary policy issued by the primary insurer to the primary insured (sometimes called "underlying insurance").

PURE PREMIUM - That portion of the premium which covers losses and related expenses, i.e. includes no loading for commissions, taxes, or other expenses.

PURE CAPTIVE INSURANCE COMPANY - Any company that insures risks of its parent and affiliated companies. Single parent Captive.

RECIPROCAL OR RECIPROCAL RISK RETENTION GROUP - Some domiciles allow risk retention groups to be formed as reciprocals. A reciprocal risk retention group is an unincorporated association of individuals or entities that exchange contracts of insurance through an attorney-in-fact, which acts as an agent or manager. In a reciprocal, profits (including investment income) and losses are allocated back to each member's subscriber savings account. Essentially all income (and the related income tax) reverts back to the members. Thus, the reciprocal structure may provide a tax advantage to groups whose members are non-profit entities. An attractive feature of reciprocals is that new policyholders can join in a way that is fair to both them and long-standing policyholders because of the way profits and surplus contributions are accounted for. Reciprocals can also be more flexible because each one is different, based on the membership agreements and bylaws.

REINSURANCE - Insurance bought by insurers. A reinsurer assumes part of the risk and part of the premium originally taken by the insurer, known as the primary company. Reinsurance effectively increases an insurer's capital and therefore its capacity to sell more coverage. The business is global and some of the largest reinsurers are based abroad. Reinsurers have their own reinsurers, called retrocessionaires. Reinsurers don’t pay policyholder claims. Instead, they reimburse insurers for claims paid. (Also see Treaty reinsurance; Facultative reinsurance)

RENT-A-CAPTIVE - Under these programs, the policyholder is insured by the Captive without owning, or at least, without voting control of the Captive. The Captive facility "rents" its capital, surplus, and license to the policyholder and usually provides administrative services, reinsurance, and/or an admitted fronting company. A Rent-a-Captive can be structured as a protected cell, which is the legal segregation of the accounts of each program from the liabilities of every other program and those of the Rent-a-Captive itself.

RETENTION - Usually used in reinsurance, this is the amount of liability retained by an insurance company and not ceded to a reinsurer.

RETROSPECTIVE RATING PLAN - One in which the final premium is based on the insured's actual loss experience during the policy term, subject to a minimum and maximum premium, with the final premium determined by a formula.

RISK-BASED CAPITAL - The need for insurance companies to be capitalized according to the inherent riskiness of the type of insurance they sell. Higher-risk types of insurance, liability as opposed to property business, generally necessitate higher levels of capital.

RISK MANAGEMENT - Management of the varied risks to which a business firm or association might be subject. It includes analyzing all exposures to gauge the likelihood of loss and choosing options to better manage or minimize loss. These options typically include reducing and eliminating the risk with safety measures, buying insurance, and self-insurance.

RISK RETENTION GROUP (RRGs) - Is an entity created under the federal Liability Risk Retention Act, and licensed in any one state to write liability insurance; is regulated as a captive insurance company; and may operate nationwide, provided it properly registers with each state in which it proposes to solicit or write insurance.

SELF-INSURANCE - The planned assumption of risk.

SPONSORED CAPTIVE - The sponsored captive structure is actually an adaptation of two other group captive concepts -- rent-a-captives, in which participants "rent" the necessary licenses and capital from the owner of the rent-a-captive, and protected cell arrangements, which is structured to have separate underwriting accounts called segregated cells. The participant is only exposed to the risk of its own underwriting performance. Legislation protects the segregated cell from the liabilities of the other cells instead of relying on a contract for protection.

SPONSOR - The legal entity that contributes capital to form a sponsored or association captive.

TAX REFORM ACT OF 1984 - Included two sections that increased the tax bill of an offshore captive insurer defined as a controlled foreign corporation. One section redefined income related to the insurance of US-based risks as US-source income instead of foreign-source income. Another section made income from the insurance of related risks in foreign countries taxable in the current year. The net effect of these two changes was to eliminate most tax advantages for an offshore single parent captive.

TAX REFORM ACT OF 1988 - The major change imposed by this act affected offshore group captives in that the definition of a U.S. shareholder was changed from an ownership interest of 10 percent or more to any shareholding interest.

TREATY REINSURANCE - A standing agreement between insurers and reinsurers. Under a treaty each party automatically accepts specific percentages of the insurer’s business.