What Is Captive Insurance?

Captive insurance is where a company creates its own insurance subsidiary to provide customized coverage for its specific risks, offering potential cost savings and greater control. The primary objective of a captive insurance company is to insure and mitigate the risks of its owners.

A captive insurance company  is created to either augment or replace existing insurance coverages, finance arrays of exposures, or render coverage for peculiar risks. The rise and ever-changing dynamics of risks will always test the capabilities of traditional insurance industries. Hard markets can emerge, leading to increased premiums and coverages with stricter terms and conditions. 

Captive insurance companies have been around for many decades. The first captive insurance company was formed back in the 1950s. Since then, there has been significant growth in the captive insurance market both domestically and offshore.

For a business, a captive insurance company is a game-changer. It is a flexible and cost-effective means of self-insurance that companies use to mitigate and finance risks. As traditional insurance becomes more problematic and premiums keep increasing, many business owners are turning to captive insurance companies as their ‘calm port in the storm’. 

At Risk Management Advisors, we specialize in assisting companies to develop, create, and ultimately manage their own captive insurance companies. Discover if a captive insurance company is right for your business.

A captive insurance company is commonly defined as a subsidiary or separate legal entity that is established, fully owned, and controlled by its parent entity. It is also referred to as a "captive" or "captive insurer", while the parent entity is called the "insured(s)".

The primary objective of the captive is to insure and mitigate the risks of its owners. Captives are created to either augment or replace existing insurance coverages, finance arrays of risk exposures or render coverage for peculiar risks.

A captive operates like a regular insurance company. However, the following are some of its distinguishing features:

  • The insured fully owns and directly controls the insurer.
  • Owners put their capital at risk.
  • Benefits from financial rewards are obtained from the direct control of the captive.

A captive should be established as a C-Corporation, or any other legal entity taxed as a C-Corporation to be recognized by the IRS. It must be licensed and domiciled as an insurance company through a state or foreign jurisdiction. This jurisdiction must operate with the legislation that allows captives to operate. There are many domestic and offshore jurisdictions where a captive can be domiciled. The largest single jurisdiction is Bermuda, followed by the Cayman Islands. While in the US, Vermont is the largest catering to the captives formed by Fortune 500 companies. In the past several decades, states like Utah, Delaware and North Carolina have emerged as viable options, particularly for mid-market companies.

In a captive insurance company:

  • The captive manager and business owner analyze the existing coverage, exclusions, premiums, and insured losses
  • The entities to be insured by the captive highlight any other potential insurable risks
  • The captive assesses the risks, writes policies according to the risks, determines premium amounts (with third party actuarial support), and receives the premium
  • The premium paid by the business to an admitted captive insurance company may be tax deductible
  • The captive invests the premium payment for future claim disbursements

A captive must meet certain requirements before being recognized as legitimate from the IRS standpoint. These requirements allow premiums paid to the captive to be deductible for federal tax purposes. They include:

  1. Risk Transfer: The risk to be insured must be transferred from the insured to the captive insurer. The insurer must bear all potential losses under the policy terms. Consequently, the captive insurer must have sufficient capital to guarantee effective risk transfer.
  2. Risk Distribution: A captive insurer must be able to provide coverage for a substantial number of identifiable independent risks. Risk distribution incorporates the statistical phenomenon known as the law of large numbers. This allows the insurer to reduce the chance that a single claim will exceed the amount of premiums taken in.
  3. Insurance Risk: The captive must only manage risks of losses that arise through underwritten insurance coverage. Other risks that arise from business, such as investment losses, are exempted from captive insurance. When setting premium levels, a proper insurance process for real risks must be followed.
  4. Common Nuances of Insurance: The captive must operate according to the conventional protocols of an insurance company. This means that aside from the unique features of a captive, every other process should be like a normal insurance company—processes like writing risk-based premiums, financing risks and creating reserves for keeping funds.

Why Form A Captive Insurance Company?

Total reliance on conventional markets to manage and mitigate risks is typically not a good business strategy. This is because they may not be capable or willing to handle the company's specific needs. This is a big motivation behind the establishment of captive insurance companies.

The benefits of a captive insurance company are many. For these benefits to be reaped, it is important to carry out a cost-benefit analysis before making any crucial decisions. Adequate resources to establish and maintain a captive structure should also be taken into consideration. The following are some of the many advantages of having a captive insurance company:

  1. Stability of Budget Allocation
    Fluctuations in the overall insurance market will always influence the pricing of conventional insurance firms, thereby neglecting the key areas of risk that insureds experience. A captive insurance company is independent of the insurance market. So, the insureds can set their own pricing according to their budget and enjoy a satisfactory and stable price for coverage of losses. As a result, the organization also has better fiscal planning and control to better manage cash flows over a long period of time.
  2. Maximum Control of Risk Management System
    The insureds of a captive structure are fully in control of every operation of the captive insurance company. Risk management is efficiently carried out to meet the owners' needs with the captive insurance company as a central hub.
  3. Better Management of Claims
    In a captive insurance structure, there is a perfect alignment of interests. At times, a commercial carrier makes claims decisions that an insured may not agree with. The captive insurance company owner and his management team are ultimately in control of this process. Claims are managed, processed, and paid within a relatively shorter period.
  4. Substantial Decrease in The Cost of Risk Management
    There are unavoidable costs associated with risk management and insurance coverage. These costs always increase when dealing with traditional insurance firms. For instance, premiums paid must cover the insurer's acquisition costs, broker commission, profit, administration, and overhead costs. Lately, wild increases in reinsurance costs have been pushed down to the retail customer.
    Although setting premiums for captive insurance companies will require some similar costs, it is less compared to the conventional market. The exclusion of much of the general overhead of commercial carriers previously noted allows some immediate savings. As a captive insurance company matures and increases its capital base, owners typically increase the level of coverage, thus reducing the pro rata cost of risk management.
  5. Increased Cash Flow from Unearned Premiums
    One of the main aims of setting up a captive insurance company is the freedom to collect the balance from paid premiums as investment income. This works well in a long-term scenario, where premiums are paid ahead of time, and losses are, in turn, paid down the road. This ability to “earn the float” has attracted many large, well-known entrepreneurs into the insurance space.
  6. Provision of Customizable Coverage
    In a realistic setting, there are risks that the traditional market is incapable or unwilling to cover. The insurance industry has historically been slow to respond quickly to the needs of business owners. Contrarily, creating a captive insurance company allows for the coverage of these atypical risks according to the needs of its owners. For example, cyber liability insurance was unavailable not too long ago. A captive insurance company issued the first cyber liability cover and now it’s a fairly common commercial insurance option.

Captive Insurance Risk Management

Risk management involves identifying, evaluating, and responding to risk factors that threaten the survival of a business. As an insurance company, a captive insurance company is a good medium for effective risk management. A well-established captive insurance program should aid in reducing the possibility of risks ensuing by developing and using proactive measures.

Captive insurance risk management should also involve forecasting possible risks and their impact on business. A captive insurance company can improve risk management through the following ways:

  1. Conducting and preparing a comprehensive analysis of possible risks to manage.
  2. Design a risk management strategy to help safeguard assets. Annual reviews are used to gauge the captive insurance company's risk management performance.
  3. Deciding what reserves to hold in the captive insurance company to optimize the business' risk management of the insureds.

To efficiently manage and mitigate risks, the captive insurance management must be adequately qualified to run the captive insurance company. Domicile legislation and requirements should also be considered. The captive insurance company's domicile and actuaries usually require that sufficient funding be made available for the captive insurance company to function properly.

Captive insurance premiums should be substantial for coverage and reserves. Before setting up a captive insurance company, the information gathered through feasibility research should aim at achieving long-term risk management with a captive insurance company and not short-term. Utilizing credible, third-party actuaries in this effort is important.

A good risk management strategy will integrate a captive insurance company along with conventional insurance.

How To Set Up A Captive Insurance Company

Below are the steps on how to form a captive insurance company:

Decide on The Most Suitable Captive Insurance Model/Structure

Having an in-depth understanding of captive insurance is imperative. After getting basic knowledge, the next step is to choose which captive insurance model is best. This gives you a headway to setting up your own captive insurance company.

Prepare a Captive Insurance Feasibility Study

After deciding on a suitable captive insurance model, the next step is to carry out intensive research on the feasibility of the model. This is a crucial phase since a new company is to be established.

The feasibility study provides an outline of the model, its practicability, challenges, costs, and risk management. It is conducted to assess the chosen model's ability to meet the needs of the company. It also helps to determine the most suitable domicile with captive insurance-enabling legislation.

Employ A Suitable Captive Insurance Manager and Team

As a newly established company, a captive insurance company needs a manager and a competent team for operations to run smoothly. Captive insurance managers are firms or persons that are approved by captive insurance regulators to carry out the administration and execution of the managerial function of a captive insurance company. The captive insurance manager or representatives may participate as an executive, non-executive, or adviser on a captive insurance company's board.

Choose A Suitable Domicile

A captive insurance domicile is defined as a state, country, or territory that issues a license to a captive insurance company and has direct supervision over it. Captive insurance companies must be domiciled locally or internationally. Over 30 states currently have captive insurance-enabling legislation.

A suitable domicile should have stable legislation that enables captive insurance companies to operate within its borders. Other essential factors to consider when choosing a domicile are ease of access, overall cost, support service, and approach to regulation.

Complete and Submit a Captive Insurance Application

All required documents, including the financial disclosures, tax information, and feasibility research files, will finally be submitted to the domiciling authorities.

The domicile authorities review the documents and arrive at a final decision within 90 days or more. During the application process, captive insurance managers can contribute to further description of the captive insurance company and its future operations. The choice of a competent captive insurance manager will help ensure that a formation application is approved.


Captive insurance companies are legal, regulated insurance companies established to insure a parent organization. They are excellent, cost-effective methods for business owners to manage their risks and improve cash flow. Unlike conventional insurance companies, captive insurance companies can provide coverage for unique business risks because the captive insurance owners are the same as the business owners and fully understand the risks of their business.

To be recognized by the IRS as insurance companies, captive insurance companies must fully meet the requirements set forth by the Service. They must be taxed as C-corporations (or LLCs taxed as C-corporations), capitalized, and domiciled in a suitable jurisdiction. Captive insurance companies that elect to be taxed under IRS Section 831(b) enjoy special taxation not available to other corporations.

To create a captive insurance company, a feasibility study of captive insurance companies and captive insurance models must be done prior to formation. A captive insurance manager is hired, and an application to a suitable domicile is submitted. The cost required to start a captive insurance company varies by model and must be well-designed.

Setting up a captive insurance company is a huge decision and should be envisioned as a long-term venture. If well-managed, captive insurance company owners can enjoy a wide range of business benefits.

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