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Simplifying Self-Insurance & Captive Insurance
Ever considered self-insuring yourself? Well, most individuals do it unknowingly but unfortunately inappropriately! Put simply, when one is underinsured, one is (unknowingly) relying on one’s savings in case the risk event occurs. While self-insurance certainly saves the cost of insurance premium it implies setting aside a huge amount of fund to be kept aside to act as a cushion against the unfortunate events. Not surprisingly there are only a very few individuals who can afford that luxury and hence most of us rely on insurance companies to protect us!
Now that we have a feel for what self-insurance would mean for an individual, let’s extend this concept for the group of people or an organization. When a set of people come together to protect each other against the risk, it is easier to have a bigger pool of funds and risk events also become more predictable. This is very similar to the P2P insurance arrangement that I have talked about in the two articles. The first one describes the concept and in the more recent one, I have played devil’s advocate to balance the hype of P2P insurance.
The pooling of the funds and risks sure seems to be a good idea and indeed works quite well under “normal” circumstances. This model, however, can fail in case of extreme scenarios, which, in insurance parlance, is referred to as catastrophic events. For example, if the insurance pool is aimed at covering cars. Under normal circumstances the chances of car accidents, damages and thefts are predictable but what if a parking lot catches fire damaging most of the cars parked? The pool of funds may not be sufficient to cover for such huge losses. Reinsurer come to rescue for the insurers by covering the tail risks!
While the idea of reinsurer helping self-insured groups looks good in theory, there haven’t been many instances of reinsurers helping an organization especially when they choose to cover only their employees. And then the organizations are left with two choices i.e. to go the normal route and get cover from an insurer (who in turn would get itself reinsured) or form a captive insurance subsidiary!
Captive insurance companies are typically subsidiaries of a group company with the aim to cover employees of the group or the companies under the group. They are regulated like any other insurance companies and have access to reinsurers like traditional insurance companies have. Wait a minute, did I say, “regulated like any other insurance companies”? Yes! But then why would anyone go down the captive insurance route if is going to be as onerous as running an insurance company? Let’s find out!
· Comprehensive Insurance Coverage: Traditional insurance companies offer insurance covers and have a lot of clauses to protect them against extreme scenarios and frauds. These, in turn, help them to offer cover at affordable premiums. But some employers might want to have a more comprehensive cover for their employees and it may not be feasible for traditional insurance companies to offer it
· Retained Earnings: Traditional insurance companies, like any other business, are run for profits and their premiums includes margins making the cover expensive. Since the group doesn’t get benefited from overcharging its subsidiaries the premiums offered by the captive insurance company would be cheaper even in the “hard” markets!
· Access to Reinsurers: While catastrophic events are rare, they sure can wipe off all the funds of any insurance company and captive insurance companies are no exception. Since captive insurance companies are like any other insurance companies, they also get access to the reinsurers across the globe
· Tax Advantages: The captive insurance companies could be part of the overall tax planning strategy and bring in tax advantages.
· Simplified risk transfer: Captive insurance companies make sense for the bigger group which are generally spread in multiple countries. In the absence of an insurance captive, these companies will have to get their insurance arrangements changed according to the offerings in the local market and the prevailing regulations. Not the best situation to be in!
Having understood the captive insurance at a high level, one would wonder why this is not a common concept. The concept of captive insurance is not unheard of. In fact, they have been around for several decades and as of 2016, there were about 7000 captive insurance companies across the globe. However, it needs a scale of a certain size before companies can consider having captive insurance subsidiary. For example, Uber decided to take captive recent route recently and, in their disclosure, they claimed to have an insurance reserve close to US$3.0 billion at the end of 2018!
I hope that you found this article helpful and now have a feel for the terms self-insurance and captive insurance. Should you have any questions on these or insurance, in general, please do reach out to us at firstname.lastname@example.org. And of course, I go live on 6th May at 8 PM SGT on Twitter for the #AskTheActuary session. But don’t wait to tweet your questions, you can tweet them anytime including now!
Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.