Why the Growth of Captives?

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Over the last few years, several states have enacted laws which allow captives to be domiciled in their state. New Jersey is one of the many states that has recently implemented a department that allows captives to be formed and governed in the state. Captive governance is new in the U.S., as Captive laws in the U.S. were first passed in the 1970s by three states.

Currently, over half the states in the U.S. have Captive laws enacted. The growth of state departments is a direct result of the growth of captives. In the past five years captives domiciled in all U.S. states have grown from 1,701 in 2009 to 2,868 in 2014 (1). There is no question that the market is growing, but the question then becomes why is there so much growth in the formation of captives?

In order to explain why captives are being formed, one must first explain what they are. A captive is a wholly owned subsidiary formed to almost exclusively provide insurance to its parent company, where the parent company is not an insurance company. They are often thought of as a form of self-insurance. There are different types of captives with the most common being Single-parent captives, Group captives and Risk Retention Groups (RRG). Captives can be set up to insure any type of risk a standard insurer would insure and have the flexibility to insure additional risks.

Captive formation may allow additional benefits to a company not provided by a traditional insurer and therefore has been a major cause of growth. The following is a list of benefits of forming a captive:

  • Cost Reduction: Costs can be more carefully analyzed and supervised, lower administrative costs
  • Risk Management: More control of risk management
  • Cash Flow: Premium payments can be more flexible as opposed to premiums paid in advance
  • Reinsurance: Access reinsurance at lower rates than a commercial insurer
  • Actuary: Uses parent companies data along with industry data to obtain more accurate numbers
  • Underwriting: Control of all underwriting procedures
  • Insurable Risks: Flexibility to select the insurable risk
  • Tax Advantages: Special tax treatment
  • Investment Income: Able to more closely manage investment income

The benefits of a captive compared to a traditional insurer can be desirable for many companies; however, the benefits must outweigh the risks. The growth of captives in the market shows that many companies are seeing the benefits outweigh the risks. Still, each company must determine their options on an individual level. Captive formation needs to be discussed with knowledgeable professionals in the industry, which would include consultants and accountants with familiarity in the insurance industry.

(1) http://www.iii.org/issueupdate/captivesandotherriskfinancingoptions1/8

Raza-Irfan Irfan Raza, CPA
609-520-1188
iraza@withum.com 

 

Shawn Gillon, CPA

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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals.

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