Captive Insurance companies represent a special case of risk retention. A captive insurance company is an entity crested and controlled by a parent, whose main purpose is to provide insurance to its corporate owner.
The ideology behind this method is that the parent company may save in terms of overhead costs and profits which would otherwise be charged by the insurance company.
Also the insured companies claim premiums as expenses, which may lead to advantages in terms of potential cash flows. These captives may either be pure captives or group captives.
A Pure Captive is an insurance company established by the parent (generally into non-insurance business) organization to provide insurance cover to itself or its subsidiary or affiliated organizations.
Group Captives are those formed by a group of companies for providing insurance cover to control their respective and collective risk. In U.S terminology these are also known as “trade association insurance companies.”
Motives Behind Captives
Optimized Loss Prevention Benefits
The benefits enduring from loss prevention are available directly to the insured.
Economies of Scale
Groups with several subsidiaries can enjoy the benefits of perfectly tailored insurance products made available to cover risks.
Non-availability of Insurance
Captives provide to cover risk exposures for which covers are otherwise not available in the market.
Stability of Earnings
The captives reduce the chances of adverse impact of sudden fluctuations in profits on the firms.
Cost and Tax Advantages
Obviously, as said earlier, captives reduce cost of risk financing and provide gains in the regime of differential taxes.
This example will make this clear:- War is an example since most property and risks are net insured against war, so the loss attributed by war is retained by the insured.
Also any amount of potential loss (risk) over the amount insured is retained risk.