348 / 462
GAZETTE
NOVEMBER 1991
The growth of captive insurance
and the attraction of the I F SC
The establishment of the International Financial Services Centre
(IFSC), has resulted in Ireland becoming the most attractive
domicile
for captive insurance companies in Europe. There will be
a rapid increase in the number of such companies incorporated here
in the immediate future.
A captive insurance company is usually a
wholly owned
subsidiary
of a company which provides a range of insurance policies for its
parent. It is called a captive because it only provides policies for
its parent, not for any outside parties. Instead of paying premiums
to an outside insurance company, the funds are paid to the captive
subsidiary.
Captive insurance
In today's world managing the risks
and exposures of a company is a
difficult and important task. One
has only to think about disasters
such as the oil spill in Alaska,
chemical escapes in India and the
collapse of a crane on a con-
struction site in the middle of San
Francisco, to realise the potential
disasters facing all businesses
today. Traditionally, management
protected the corporation by
purchasing insurance coverage
from insurance companies. For
companies operating in hazardous
industries, this option is becoming
cost-prohibitive and in some cases
impossible to obtain. To solve this
dilemma many companies are self-
insuring through captive insurance
companies.
A company can set up and manage
its own captive or the company can
hire a management company to
undertake the legal arrangements,
establish and manage the captive.
Captives can be of any size and can
be established anywhere but are
often set up off-shore for tax
reasons.
The f unc t i ons of a cap t i ve
insurance company are the same
as any insurance company.
Management invests the funds
generated from the premiums
received and assesses the risks
involved. It is seldom possible for a
captive insurance subsidiary to
330
by
Muiris O'Ceidigh
B.A., LL.B*
have the resources to cover all of
the potential losses of the parent.
For this reason it is usually the case
that captives look to reinsurance to
cover the major part of the risk.
Captives and reinsurance
Reinsurance is the term used for
when a company takes over
an
insurance risk
from another insurer.
It involves a financial contract that
indicates the type of risk, the
amount of cover required and the
premium charged. The standardisa-
tion of reinsurance risk cover means
that contracts for risk can be bought
and sold as investment items by any
reinsurance company. The competi-
tive nature of this market has meant
that market forces have established
minimum costs for the cover of each
risk segment. The reinsurance
market provides an efficient low cost
way for captive insurance com-
panies to spread the cover of the risk
they underwrite.
There are two types of insurance
captives. There is the "reinsurance
captive" which uses "fronting
companies" and does not directly
insure its parent. In this instance
the parent company's insurance
will be spread between a group of
fronting insurance companies.
These fronting companies then,
rather than go to the reinsurance
market, will hold on to about 5% of
the total business and pass the
95% on to the reinsurance captive.
The reinsurance captive then
collects the premiums from the
fronting companies, and places its
business on the reinsurance
market. Therefore a "reinsurance
captive" is essentially based on a
four tier structure of parent
company, fronting companies,
reinsurance captive and the
reinsurance market. The fronting
companies continue to carry out
inspections and on-site work at
which they are expert, and the
reinsurance captive makes money
out of the reduced premium cost on
the reinsurance market and the
improved cash flow.
The "direct-writing captive" on the
other hand insures the parent
directly, taking 100% of the business
and removes the fronting companies
from the structure, resulting in a
three tier structure of the parent
company, the captive and the rein-
surance market. While this type of
operation involves the undertaking in
the on-site inspection and advisory
work, it has the advantage of full
control of cash flow and enables
negotiation of timing of payments
directly with both the parent and the
reinsurance market with a conse-
quent positive effect on interest.
Muiris
O'Ceidigh