Company formed to insure the risks of its parent corporation. Reasons for forming a captive insurance company include:
1. Instances when insurance cannot be purchased from commercial insurance companies for a business risk. In many instances companies within an industry form a joint captive insurance company for that reason.
2. Premiums paid to a captive insurance company may be deductible as a business expense for tax purposes according to current Internal Revenue Service rules. However, sums set aside in a self insurance program are not deductible as a business expense. Therefore, although costs will be insurred in creating and operating a captive, they may be rouped over time by tax savings.
3. Reinsurance can be obtained through the international
reinsurance market. Reinsurance is essentially insurance for an insurer, and therefore, the captive does not have to bear the entire risk of loss if it has an established reinsurance program. While premiums must be paid for reinsurance, the structure of the reinsurance program can be layered to keep premiums relatively low in comparison to the amount of protection provided against catastropic losses. In contrast, self-insurance programs, because they are not insurers as such, cannot obtain reinsurance, and thereby must retain all risk.
4. Investment returns can be obtained directly on its invested capital.
However, competent personnel to manage and staff the company can be costly; and further, a catastrophic occurrence or series of occurrences could bankrupt the captive-which is why reinsurance through a stable reinsurer is critical.