A captive insurance company is a subsidiary established by one or more commonly-owned businesses to insure the risks of the controlling entity and/or its affiliates or its individual owners. Businesses have been using captives for decades as a risk management tool. There are in excess of 5,000 captives, including group and cell captives, established in various domiciles throughout the world for the benefit of all types of industries.
Like any other insurance company, self insurance is subject to regulation. A captive will be subject to the same corporate governance matters as other subsidiaries in the consolidated group, including establishing a sound business plan.
Why captive insurance?
One of the primary goals of a captive insurance company is to provide improved risk management for an organization. Some of the risk management benefits that a captive insurance company can achieve:
- Increase financial efficiency of risk management
- Create flexibility in responding to changes in risk retention and risk transfer strategies
- Mitigate the impact of marketplace pricing and capacity volatility
- Obtain coverage for risks traditionally not readily available or economically feasible in the commercial markets
- Obtain access to reinsurance markets
- Maintain control over claims analysis
- Create centralized accountability for risk management of diverse operations, business units or insurance programs
- Obtain access to government programs (e.g. terrorism insurance)
- Reduce insurance administration costs and recapture underwriting profits
The captive insurance company must be capitalized. In order for the captive to have an impact on the corporate group, it requires a material amount of capital and premium funding. As a result, there may be an opportunity cost associated with lower yield captive investments vs. higher parent “hurdle” rate (ROI).
Who should consider a captive insurance company?
The following are characteristics of companies where a captive insurance company may be beneficial to the organization:
- Financial stability
- Good risk management practices
- Decision to pursue a captive insurance company is driven by an interest in financing assumed risk positions
- Substantial operations in high tax jurisdictions
- Multiple global operating entities with insurable risk spread throughout
- Long-term commitment to the use of a captive insurance company
- Reasonably predictable insurance risk
- Sophisticated financial planning
- Existing balance sheet reserves for self-insured business risk exposures or large deductibles (i.e., worker’s compensation, general liability, professional liability, etc.)
The tax status of the captive insurance company for U.S. federal income tax purposes is an important consideration. If the captive qualifies as an insurance company for U.S. federal income tax purposes, then premium paid to the captive is tax deductible by the insured entity, and the captive is allowed favorable tax treatment under Subchapter L of the Internal Revenue Code.
Making the right choices early
Successful captive operations need to be thoroughly researched and properly planned. Every client has different needs; consequently every captive structure is different. Maximizing the benefits to be gained from your captive means understanding and responding to the various business needs and concerns within your organization. To do this effectively, you need a service provider with a broad range of skills.
PwC has a proven track record of delivering high-quality captive insurance solutions throughout the Captive Lifecycle. What differentiates us is a multi-disciplinary team that can provide access to risk management, actuarial, tax (US federal, state and international), regulatory and accounting professionals. We can assist you with all aspects of the captive establishment process including:
- risk management reviews;
- tax structuring and opinions;
- feasibility studies;
- formation assistance;
- regulatory consulting.
How does your captive insurance company stand up?
While the Internal Revenue Service has accepted the use and role of captive insurance arrangements as an integral part of a comprehensive risk management strategy, they continue to challenge captive insurance arrangements which fail to comply with the principles and guidelines established by the courts in defining “insurance” for US federal income tax purposes. In response, PwC has developed a comprehensive Captive Health Check to assist companies in assessing how their captive insurance arrangements stand up against these principles and guidelines and to serve as a platform for identifying best practices and possible enhancements to improve the captive’s financial benefits.
Why a Captive Health Check?
First – most corporations change over a period of 5 or 10 years. They acquire companies, dispose of companies, start and end lines of business. Their structures and operations change over time. These changes can provide new opportunities for enhanced risk management and tax benefits.
Second – substantial changes have occurred in the tax landscape dealing with captive insurance companies. The Service has issued a number of Revenue Rulings setting out what it believes are the requisite fact patterns for a valid captive insurance arrangement, and more recently the Tax Court has examined captive insurance arrangements and further clarified the requirements for a valid captive insurance arrangement.
The Captive Health Check provides the captive owner with an experienced overview of the structural and functional aspects of their captive insurance company and is designed to provide the captive owner with a range of benefits, including:
- Identifying structural and operational deficiencies and /or opportunities in current captive insurance arrangements from a US federal, state, and international tax perspective; and
- Providing the captive owner with recommendations to strengthen the overall tax position of the captive, while at the same time considering the overall risk management and business goals of the company.
How do you release your captive’s embedded value?
Many companies seek to rationalize their captive arrangements and release capital or simply seek to exit third party lines of business to enable their captive insurance affiliates to focus on core group insurances.
Restructuring and rationalization of captive arrangements can mitigate exposures to legacy liabilities, generate cost savings and financial value through:
- Prevention of deterioration of reserves on third party business and release of redundant reserves;
- Protection of reinsurance assets through accelerated collection activity;
- Savings in ongoing administration and management costs;
PwC can assist clients in reorganizing their captive insurance arrangements in the following ways:
- Accelerated portfolio de-scaling through commutation advice and support;
- Whole captive closure through structured exit mechanisms such as Schemes of Arrangement or Statutory Liquidation;
- Performance and process improvement in operational areas such as claims handling and reinsurance; and
- Actuarial support in valuing and managing complex related or third party exposures.
Our Captive Practice is geared to meeting the needs of our clients and their stakeholders. Our leading insurance industry expertise and captive specialization allows our professionals to focus on helping you resolve your business issues. We can help you make it all work. We have excellent working relationships with the major domicile regulators and captive management companies and are accustomed to helping you meet the demands of corporate timetables and objectives.