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The COVID-19 Pandemic: Opportunities and Implications for Captive Insurance

The COVID-19 Pandemic: Opportunities and Implications for Captive Insurance

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The COVID-19 Pandemic: Opportunities and Implications for Captive Insurance explores the challenges presented by today's business and economic upheaval, as well as the hardening insurance market, and what it means for the captive insurance industry.

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Group Captives, Cell Captives, and Risk Pooling Arrangements Guide

Company Percentages-SF
February 01, 2017

By P. Bruce Wright, M. Kristan Rizzolo, and Saren Goldner
Sutherland Asbill & Brennan LLP

Multiple participant captive insurance companies can take a number of forms, such as group captives and cell captives. It has also become common for captive insurance companies to share risks through pooling arrangements. These types of captive insurers along with the varying economic results they may produce for participants are discussed below as are pooling arrangements.

Single Corporate Format. This format is commonly referred to as a group captive. It generally involves the formation of a single entity to insure the risks of those parties investing in it and their affiliates. For purposes of discussion, we will limit our analysis to a group of single entity investors/insureds.

A group captive can be formed as a stock company in which each investor purchases shares or a mutual or a reciprocal to which capital is contributed.1 Thus, risks are commingled and shares of profit generally determined based on proportion of ownership. Sometimes group captives allocate net profit or loss to what is, in essence, a capital account maintained for each of the owners based on a formula that may take into account the experience of the entire company, or some portion of the capital account holder's losses, expenses, profit, etc., and some portion of the entire company. Also, there are often limitations on withdrawal of capital in the event a member ceases to be an insured. These limitations are imposed to preclude an adverse effect on the other participants caused by an unexpected reduction of capital or adverse loss development for years in which a member participated that occurs after a member leaves.

Generally, there is a board or governing body whose rights and obligations are spelled out in the bylaws, or in the case of a reciprocal, the entity is operated by an attorney-in-fact whose authority is similarly defined by agreement.

Cell Companies. Cell companies (sometimes referred to as sponsored captives, segregated portfolio companies, protected cell companies, etc.), generally have a core or general account and individual cells that are not responsible for losses or expenses of the other cells or the core. Each cell will have one or more participants and will be governed either by a participants' agreement or by bylaw provisions of the cell company or both. Each cell is thus separate from all other cells and has its own capital structure and business. Several separate insureds can participate in a single cell as if it were a single insurer, or in separate cells. When insured in separate cells, each "investor-participant" will only bear the economic effect of its own risk that has been insured to that cell.

Pooling Arrangements. Pooling arrangements are sometimes employed as a way to reduce loss variability and achieve the risk shifting and risk distribution necessary for premiums paid to a captive insurance company to be deductible for the insured parent.  Although risk pooling arrangements may differ in structure, the effect is to take risks of multiple captive insurance companies and share them among the participating captives. Thus, for example, each of 10 captive insurance companies owned by 10 unrelated insureds (each of which insures only the risk of its owner) can cede all (or a portion of) its assumed risk to a single unrelated entity, X, and then assume a portion of X's business so assumed. For ease of illustration, assume each captive cedes the same amount of premium. In this scenario, each captive would typically participate as a reinsurer in 10 percent of the pooled risk and would assume as a cedent 10 percent of each cedent's risk (including their own). So, in the end, each captive would have 90 percent of the other parties' risk.

In some cases, pools are entirely operated by a third party who decides who can participate and who cannot. In other cases, a third party administers the pool, but the pool members make decisions as to terms, who can participate, etc.

Generally, pools operate on an annual basis as it facilitates accounting for participant shares in the pool that would be affected by members either withdrawing or joining.2

P. Bruce Wright, M. Kristan Rizzolo, and Saren Goldner are partners in the tax department of the law firm of Sutherland Asbill & Brennan LLP. Mr. Wright and Ms. Goldner are located in New York, and Ms. Rizzolo is located in Washington.

  1. If only liability insurance is being written, a risk retention group may be used as an alternative, provided it meets the requirements of the Liability Risk Retention Act of 1986.
  2. For a more comprehensive discussion, see the section titled "Insurance Characterization for U.S. Federal Income Tax Purposes - Risk Shifting and Risk Distribution," in "Tax Implications of Risk Financing" by P. Bruce Wright, Esq., and Saren Goldner, Esq., in the IRMI reference service Risk Financing. If you subscribe in IRMI Online, you will find the discussion here. If you subscribe in Vertafore ReferenceConnect, you will find the discussion here.

Copyright © 2017, International Risk Management Institute, Inc.

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