A captive insurance company helps its sponsors establish regular cash flow for their risks and offers them a direct choice of reinsurance.
It also provides a tax benefit, since insurance premiums are a deductible business expense while directly held reserves are not.
When a company creates a captive they are indirectly able to evaluate the risks of subsidiaries, write policies, set premiums and ultimately either return unused funds in the form of profits, or invest them for future claim payouts.
Most captive insurers are based "offshore", in places such as Gibraltar, Mauritius, Belize, Bermuda, The Cayman Islands, Ireland, Guernsey, Luxembourg, Barbados, Malta, The Bahamas, Singapore, Anguilla, the British Virgin Islands, Qatar Financial Centre and Dubai International Financial Centre.
After much investigation, he chose Bermuda, due to its geographical location, clean reputation and status as a British Dependent Territory, which avoided the risks and uncertainties often experienced by international businesses operating in politically unstable and unaccountable jurisdictions.
Healthcare corporations prefer Bermuda, due to the ease of claim payment provided by the regulatory environment.
[citation needed] In past years, Anguilla was a fast growing offshore domicile which ended in 2013.
Captives can cover lines of business, such as workers' compensation, that have relatively predictable claim rates.
A captive cannot arbitrarily set the premium amount simply to generate a deduction for the parent.
In the European Union, a new set of regulatory requirements (Solvency II) is planned with additional restrictions and responsibilities for captives and reinsurance companies.
Over 75% of the world’s captives are associated with the United States because these insurance arrangements are encouraged under the Internal Revenue Code.
[15] Under the US tax code, a Section 831(b) or "small" property/casualty captive, also known as a "micro-captive" is used by midsize companies looking for cost-effective ways to transfer risk.
[19] Captive experts say an 831(b) introduces middle market companies to alternative risk transfer and its benefits, providing this class of insurance buyers a valuable cost-saving tool long utilized by Fortune 1000 companies.
[20] This also led to a proliferation of captive insurance as an illegal tax shelter, whereby clients paid premiums up to the statutory deduction limit to entities that did not actually pool risk.