New to captive insurance? Here are some commonly used risk and captive terms:
Financing risks outside the commercial insurance system. Also refers to transferring risk using non-traditional methods, such as combining insurance and non-insurance tools.
A captive insurance company that insures the risks of members of a common industry or trade association. Participation is limited to members of the industry or association.
A captive is an insurance company created to insure the risks of its owner(s) or participants. Captive insurers are an alternative to self-insurance, in which a parent group (or groups) creates a licensed insurance company to provide coverage for itself. By creating its own insurance company, the owner(s)/participants can reduce costs, improve cash flow, and gain coverage stability and control. A captive insurer operates like any other commercial insurance company and is subject to regulatory requirements, including reporting, capital, and reserve requirements.
A company “cedes” financial risk when it reinsures its financial liability with another company.
Premiums paid to another insurer for reinsurance protection.
Funds required by each participant to meet their obligations for any losses above expected, based on the risk they bring into the pool. Collateral is kept and used or returned, depending on underwriting results and losses. The most common form of collateral provided by captive participants is a bank letter of credit (LOC), but cash may also be used. Returned collateral, or a collateral release, may be subject to approval by the Bermuda Monetary Authority.
Money that eligible participants in group captives may receive back if claims are lower than expected. These contractual payments are calculated on a predetermined schedule once all claims data is received. Distributions may be subject to approval in Bermuda.
The state or country that licenses an insurance company and has regulatory oversight over the insurer.
A captive that insures the risks of a group of non-related companies that have come together to share risk, benefit from risk management experience, and leverage combined purchasing power.
Incurred but not reported (IBNR) losses
Estimates of losses incurred prior to a financial closing date, but not reported to the insurer as of the closing date.
Letter of credit (LOC)
Within the context of captive insurance, a promise by a bank to pay certain obligations of the captive participant. LOCs are typically posted and held in trust. A letter of credit is one acceptable form of collateral or non-premium funding (NPF).
Insurance coverage purchased by an insurance company. It is a way of managing an insurance company’s risk in the event of unexpected claims.
A captive that rents its structure and services to insureds who want to create a captive program, but don’t want to create and own an insurance company.
Segregated account (or cell) captive
A form of rent-a-captive not formed by its insured, but sponsored by a third party. It is a single legal entity divided into cells. The income and loss, assets and liabilities, and rights and responsibilities of each cell are kept separate from all other cells. These types of companies have different names in different domiciles: segregated account companies (Bermuda), segregated portfolio companies (Cayman Islands), protected cell companies (South Carolina), and sponsored captives (Vermont).
Stands for “Segregated Account Program Agreement.” The document that defines the rights and obligations of each participant for the particular captive program in which they are participating.