Frequently Asked Questions
- How Are Captives Regulated? HOW
ARE CAPTIVES REGULATED?
Commercial insurance companies sell insurance to the general public and are licensed in all states in which they do business. By contrast, Captive insurance companies directly insure only their owners, who are sophisticated insureds, with the ability to manage and retain their own risk. Consequently, the degree of regulatory oversight required for captives is less than that which is required for commercial insurers. The captive is licensed in only one state, and operates under the captive insurance law of that domicile. - What is an Excess Contract?WHAT
IS AN EXCESS CONTRACT?
Insurance coverage that is written in excess of primary insurance. It's designed to increase the limits of liability, thereby providing catastrophe coverage. Excess liability coverage does not respond to a loss until the amount of the loss exceeds (or exhausts) any existing primary policy limits. Example: A primary $500,000 liability policy is written, and excess insurance is written for $2 million excess of the primary. The primary policy would pay all losses within $500,000 and the excess policy would pay losses in excess of the primary coverage, up to the excess policy limit of $2 million. - What is Reinsurance?WHAT IS
REINSURANCE?
The term “reinsurance” is often misused. Reinsurance is actually only available to insurance companies and is “insuring the insurer.” It's a form of insurance whereby one insurer agrees to indemnify another insurer for losses resulting from retained risks. Reinsurance is generally what every captive should have because it protects the fiscal integrity of the captive and its owners. 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). - What is a feasibility study?WHAT
IS A FEASIBILITY STUDY?
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. - What involvement will I have in operating
the captive?WHAT INVOLVEMENT WILL I HAVE IN OPERATING THE
CAPTIVE?
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 responsibility for 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. - What is a captive manager?WHAT
IS A CAPTIVE MANAGER?
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 domiciles Department of Insurance, or if it is a foreign domicile, it would be the Finance Ministry, Financial Services Commission, or Monetary Authority on regulatory issues and provide general consulting assistance. A captive manager can also be helpful in steering management through the captive formation process. Each domicile has a list of approved captive managers. - What services do actuaries perform?WHAT
SERVICES DO ACTUARIES PERFORM?
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). - What is a fronting company?WHAT
IS A FRONTING COMPANY?
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. - Will my captive have to use a fronting
company to issue insurance policies?WILL MY CAPTIVE HAVE
TO USE A FRONTING COMPANY TO ISSUE INSURANCE POLICIES?
Certain types of coverage require evidence of insurance from admitted insurers. In addition, some insured’s may be required to show evidence of insurance from a highly rated carrier. - What types of investments are captives
allowed to use?WHAT TYPES OF INVESTMENTS ARE CAPTIVES ALLOWED
TO USE?
As part of its business plan filed with the licensing authority the captive will need to document its investment plan including the proposed types of invested assets to be acquired and held by the captive. The regulatory authority of the domicile will review the proposed investment strategy and may approve the plan as submitted or require revisions. Typically, newly formed captives invest in bank instruments (e.g., money market funds and certificates of deposit) and highly rated marketable securities including mutual funds. - Does the captive get to keep its investment
income?DOES THE CAPTIVE GET TO KEEP ITS INVESTMENT INCOME?
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. - Does a captive pay income taxes?DOES
A CAPTIVE PAY INCOME TAXES?
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 the premium paid into the captive is to be less than 1.3 million, then the captive can elect to be taxed as a small insurance company under an IRC 831(b) election. This limits the taxation to only the investment income. - Can a state guaranty fund assess captives
who write business in their state?CAN A STATE GUARANTY FUND
ACCESS CAPTIVES WHO WRITE BUSINESS IN THEIR STATE?
No. Captives are exempt from state guaranty fund assessments. - What are the minimum capital and surplus
requirements in the typical domicile?WHAT ARE THE MINIMUM
CAPITAL AND SURPLUS REQUIREMENTS IN THE TYPICAL DOMICILE?
The statutory minimum capital and surplus requirements will vary by domicile. The amounts can vary from just a few thousand to well over a million dollars. The actual capital required will be driven by the lines of insurance and the amount of risk actually taken by the captive. 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. - What are the common sources of formation
capital?WHAT ARE THE COMMON SOURCES OF FORMATION CAPITAL?
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. - Can I use a letter of credit to capitalize
the captive?CAN I USE A LETTER OF CREDIT TO CAPITALIZE THE
CAPTIVE?
Yes, most domiciles regulation allow for a letter of credit as evidence of the formation capital. A letter of credit can satisfy both the minimum capital and surplus requirements. - What fees are involved in setting up
a captive?WHAT FEES ARE INVOLVED IN SETTING UP A CAPTIVE?
A non-refundable application fee is usually required and a licensing fee will be assessed upon approval of the application. Sometimes the domicile’s regulatory authority will charge the applicant an additional fee if it deems 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. Thus, the set up organizational costs vary between $25,000 and $250,000. Though generally, you should plan on investing $50,000 to $60,000 in the set up phase. - What is underwriting?WHAT IS
UNDERWRITING?
Underwriting is the process of selecting and rating (i.e., pricing) the risks to insure. - What is the difference between gross
written premium and net written premium?WHAT IS THE DIFFERENCE
BETWEEN GROSS WRITTEN PREMIUM AND NET WRITTEN PREMIUM?
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. - How should I decide what reinsurance
programs are appropriate for my captive?HOW SHOULD I DECIDE
WHAT REINSURANCE PROGRAMS ARE APPROPRIATE FOR MY CAPTIVE?
It is very important to consult someone experienced in forming captive programs to design an appropriate reinsurance program for your captive. Because a captive is an asset to the corporation and its owners, it is critical that a proper reinsurance program be designed for the captive that protects the captive from adverse loss development. - What are premium taxes?WHAT
ARE PREMIUM TAXES?
Captive domiciles each charge a tax on the amount of premium written by the captive. Though, in some cases, domiciles have chosen to waive the premium taxes to encourage captive formation. While on the surface this appears to be a good idea, the typical domicile charges .0025 as the premium tax for the first 20 million of premium. For most small captives, this amount is not as material to the decision process, though it should be part of the due diligence process. - How does a captive settle claims?HOW
DOES A CAPTIVE SETTLE CLAIMS?
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). - Who should I contact at Captive Insurance
Alternatives to talk about forming a captive?_____________________________WHO
SHOULD I CONTACT AT CAPTIVE INSURANCE ALTERNATIVES TO TALK ABOUT FORMING
A CAPTIVE?
Your first call should be directly to Dave McDaniel at 949-218-0521 to discuss your captive program. Setting up and managing a captive can be a very rewarding and profitable endeavor, but you should know all the facts before you make the decision.