How Captives Work

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Critical mass means Carriers take premium from a large number of insureds and use that money to pay the claims of the few that end up having claims. If two insureds are insured for $1M each and statistically one of them will have a $1M claim, the premium each should pay would be $500k plus the insurance companies profit and overhead, plus a little extra “just in case” the claims are more. If you have 10 insureds and statistically 1 will have a $1M claim, the premiums should be $100,000+ and so on. While this creates the ability for customers to obtain $1M of insurance for much less that $1M in premium, it has a drawback. Since each insured’s premium is determined by the likelihood of claims that will be paid across all insureds, the likelihood of other insureds to have a claim, or having a larger claim, being higher than yours increases your premium, even though you are a good risk. Captives allow the insured to determine which risks make up the insured group so your premium is only affected by risks that you have chosen to accept.

Reinsurance is the coverage, purchased by an insurance company, which reimburses some portion of a claim that the insurer who writes your policy has agreed to pay. For example, if you buy $2M of insurance from an insurance company, that company may or may not buy insurance for $1M of the $2M in coverage they provide to you. Most insurance companies throughout the world are not able to provide such high limits of insurance without some reinsurance support. The cost of this reinsurance is included in the rate you are charged for your total coverage. An insurance company can purchase a reinsurance policy (or treaty) that applies to all or a portion of the insurance they write, or they can purchase “facultative” reinsurance on a specific insured. The amount of reinsurance purchased, the terms and the price are negotiated solely by the insurance company. In a captive, the terms, conditions and price of the reinsurance purchased is determined by the insured.