The six Cs of captive insurance

The six Cs of captive insurance | Insurance Business

The six Cs of captive insurance

Canadian companies are navigating a time of unprecedented change. They’re facing uncertainty around the North American Free Trade Agreement (NAFTA) replacement, known as the United States-Mexico-Canada Agreement (USMCA); they’re up against an increasingly stringent regulatory environment around cybersecurity and data privacy; they’re trying to weigh up the opportunities and challenges that come with emerging technologies and digital development; and they’re battling an increasingly volatile climate which is driving catastrophic losses.

In times of disruption, good or bad, uncertainty over the risk landscape often drives businesses to start thinking about captive insurance as part of their risk management strategies. A captive insurance company is essentially a form of self-insurance whereby the insurer (the captive) is wholly owned by the insured (the business). The types of entities forming captives range from major multi-national corporations to smaller non-profits. It’s a global marketplace and it’s used by all industries. 

From an organizational standpoint, a captive insurance company promotes solid enterprise risk management. If you’re going to self-insure, you want to make sure you’re sailing a water-tight ship. Once the captive has been set-up, it can drive risk management discipline and can provide additional structure and protection around a company’s balance sheet, while maintaining flexibility in program design and providing potential savings.

“There are six Cs as to why companies form captives: cost, capacity, control, compliance, cover, and commercial,” said Patrick Ferguson, senior vice president, Marsh Captive Solutions. “A lot of companies set up captives around that first bucket – cost. They’re able to save market premiums by self-insuring part of their risk through a captive. Another good rationale for setting up a captive is that it allows access to the reinsurance markets where pricing is cheaper than buying insurance directly.

“A lot of companies are using captive solutions to tackle some of the emerging risks that are out there, such as terrorism, cyber, environmental coverages and so on. With some of those emerging risks, companies are finding it difficult to get insurance, so they’re evaluating whether a captive makes sense. A good example would be the cannabis industry. It’s a growing industry, it’s federally legal, and yet cannabis companies are struggling to get directors & officers (D&O) placements and D&O insurance at competitive market pricing. So, we’ve been in the process of working with some of the cannabis companies around whether a captive might make sense for a primary D&O layer, or even an excess layer.”

When evaluating whether setting up a captive makes sense, it’s important for companies to evaluate it as a long-term risk management objective, according to Ferguson. The benefits of a captive insurance company often don’t come to light for a few years, and many captives face some bumps in the road. For example, it’s not cost-effective for companies to self-insure their commercial auto through a captive one year, and then to drop it the following year because their loss ratios haven’t improved by the desired amount.

“Our view is that there should always be an insurance rationale for setting up a captive first – that should always be a primary reason for looking as a Canadian company at a captive,” Ferguson told Insurance Business. “However, if you do pass that hurdle, there are some tax benefits that are in play. Popular captive countries, like Barbados and Bermuda, have tax information exchange agreements in place, so that the profit that your Barbados or Bermuda captive accrues does not accrue profit from a Canadian tax perspective.”