Forming and Operating a Captive Insurance Company

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August 03, 2023 |

A toddler building a sand castle on the beach and holding a blue plastic shovel in his left hand with three orange plastic buckets next to him

Editor's Note: The following article is provided by the Vermont Department of Financial Regulation, Captive Insurance Division.

The initial process of forming a captive involves a few basic but important steps. First, identify your insurance/risk problem or opportunity and then interview and select a domicile-approved captive management firm. Your captive manager will play a critical role in guiding you through the process. Speak with managers that represent multiple domiciles so that you can find the one that best suits your needs.

After choosing a captive manager, conduct a feasibility study to determine the pros and cons of captive formation and explore domicile options that may be best suited for your captive needs. There are a number of captive types, and you will need to determine which captive type may be right for you. Meet with the domicile regulator to discuss your proposed captive. The following briefly describes nine different captive insurance company types.

Affiliated Reinsurance Company (ARC). An ARC may be formed to reinsure related commercial insurance companies. ARCs are regulated in a manner much like their commercial parent company but with greater investment flexibility.

Pure Captive. Also referred to as a "single-parent captive," a pure captive insures only the risks of the parent and affiliated companies or controlled unaffiliated business.

Risk Retention Group (RRG). An entity created under the federal Liability Risk Retention Act and licensed in any one state to write liability insurance, an RRG is regulated as a captive insurance company and may operate nationwide, provided it properly registers with each state in which it proposes to solicit or write insurance.

Special Purpose Financial Insurance Company (SPFI). A special purpose financial insurance company is used to facilitate risk securitization via a transaction or a group of related transactions, which may include capital market offerings, that are effected through agreements where all or part of the result of such transactions is used to fund the special purpose financial insurance company's obligations under a reinsurance contract with a ceding insurer. Funding may be provided by the issuance of securities, letters of credit, or other assets. SPFIs are almost exclusively formed by commercial insurance companies.

Sponsored Captive. A sponsored captive insurance company has its minimum capital and surplus provided by one or more sponsors. Sponsors must be qualified by the Department of Financial Regulation. The business of a sponsored captive may only insure the risks of participants through separate participant contracts, and the liability to each participant must be funded through one or more cells. The assets of cells are available only to satisfy the liabilities of that cell.

Industrial Insured Captive. A captive insurance company owned by multiple nonrelated organizations (industrial insureds) to insure the risks of these organizations and their affiliated companies.

Association Captive. A captive insurance company that insures risks of the member organizations of an association and of the association itself.

Branch Captive. A unit of an existing offshore (alien) captive licensed in Vermont to insure its owners and affiliates onshore. The branch is regulated as a pure captive, is taxed only on the branch writings, and may be required to use an onshore trust for the protection of US policyholders and ceding insurers.

Agency Captive. An agency captive is a reinsurance company controlled by an insurance agency or brokerage. Through a reinsurance agreement with a traditional insurer, the agency captive receives a share of the premiums written and is obligated to pay its share of claims.

Finally, prepare and submit a captive application. Once licensed and established, ongoing management and operation will impact the success of the captive. Recognizing that a captive is a long-term risk management strategy, a successful captive insurance company should have the following key attributes.

  • A clearly defined purpose and business plan for sustainability
  • A dedication to operating the captive in a manner that ensures risks are well understood and mitigated, using reinsurance as needed
  • A well-defined underwriting approach
  • A commitment to long-term and transparent relationships with various service providers (such as captive managers, investment advisers, and actuaries)
  • A thorough oversight process as provided by a captive manager within a stable and legislatively supported domicile

August 03, 2023