The Gazette 1991

GAZETTE

NOVEMBER 1991

The growth of captive insurance and the attraction of the I F SC

The establishment of the International Financial Services Centre (IFSC), has resulted in Ireland becoming the most attractive domicile for captive insurance companies in Europe. There will be a rapid increase in the number of such companies incorporated here in the immediate future. subsidiary of a company which provides a range of insurance policies for its parent. It is called a captive because it only provides policies for its parent, not for any outside parties. Instead of paying premiums to an outside insurance company, the funds are paid to the captive subsidiary. A captive insurance company is usually a wholly owned

fronting insurance companies. These fronting companies then, rather than go to the reinsurance market, will hold on to about 5% of the total business and pass the 95% on to the reinsurance captive. The reinsurance captive then collects the premiums from the fronting companies, and places its business on the reinsurance market. Therefore a "reinsurance captive" is essentially based on a four tier structure of parent company, fronting companies, reinsurance captive and the reinsurance market. The fronting companies continue to carry out inspections and on-site work at which they are expert, and the reinsurance captive makes money out of the reduced premium cost on the reinsurance market and the improved cash flow. The "direct-writing captive" on the other hand insures the parent directly, taking 100% of the business and removes the fronting companies from the structure, resulting in a three tier structure of the parent company, the captive and the rein- surance market. While this type of operation involves the undertaking in the on-site inspection and advisory work, it has the advantage of full control of cash flow and enables negotiation of timing of payments directly with both the parent and the reinsurance market with a conse- quent positive effect on interest.

Captive insurance In today's world managing the risks and exposures of a company is a difficult and important task. One has only to think about disasters such as the oil spill in Alaska, chemical escapes in India and the collapse of a crane on a con- struction site in the middle of San Francisco, to realise the potential disasters facing all businesses today. Traditionally, management protected the corporation by purchasing insurance coverage from insurance companies. For companies operating in hazardous industries, this option is becoming cost-prohibitive and in some cases impossible to obtain. To solve this dilemma many companies are self- insuring through captive insurance companies. A company can set up and manage its own captive or the company can hire a management company to undertake the legal arrangements, establish and manage the captive. Captives can be of any size and can be established anywhere but are often set up off-shore for tax reasons. The f unc t i ons of a cap t i ve insurance company are the same as any insurance company. Management invests the funds generated from the premiums received and assesses the risks involved. It is seldom possible for a captive insurance subsidiary to 330

by Muiris O'Ceidigh B.A., LL.B*

have the resources to cover all of the potential losses of the parent. For this reason it is usually the case that captives look to reinsurance to cover the major part of the risk. Captives and reinsurance Reinsurance is the term used for when a company takes over an insurance risk from another insurer. It involves a financial contract that indicates the type of risk, the amount of cover required and the premium charged. The standardisa- tion of reinsurance risk cover means that contracts for risk can be bought and sold as investment items by any reinsurance company. The competi- tive nature of this market has meant that market forces have established minimum costs for the cover of each risk segment. The reinsurance market provides an efficient low cost way for captive insurance com- panies to spread the cover of the risk they underwrite. There are two types of insurance captives. There is the "reinsurance captive" which uses "fronting companies" and does not directly insure its parent. In this instance the parent company's insurance will be spread between a group of

Muiris

O'Ceidigh