Captive
Insurers – Part 1
Twenty five years
ago, the 1986 Federal Risk Retention Act (FRRA) was created. This act allowed
similar or related businesses or groups to form for the purpose of buying
liability insurance. The Act was in response to a severe shortage of liability
insurance for certain types of business. Businesses who wanted to continue to
operate needed a strategy to protect against their vulnerability to accidental
losses. Two strategies were found - captive insurers and risk retention groups
(RRGs)
Captive
insurance companies were first created in the 1950s. This method of handling
losses lowered insurance costs for corporations and, originally, also allowed
huge tax advantages that were subsequently outlawed. In spite of that, and
because of the volatility of traditional commercial insurance companies in the
Many large
corporations wanted the investment income generated from the premiums paid to
their captive insurance companies. Additional income was also created by the
loss reserves (sums set aside for handling anticipated, accidental losses)
generated by those premiums. This provided even more motivation to form captive
insurers. Sophisticated corporate risk managers realized they could benefit
from any of a number of insurance premium-related investment income
opportunities. This was seen as yet another advantage over purchasing
commercial insurance coverage from an insurance company that controlled
premiums, loss reserves and the interest income that those funds generated.
Initially, most
offshore captives were "pure" captives (see Captive Insurers – Part 2
for more information). As time passed, many pure captives found even greater
tax advantages if they insured other, unrelated organizations. Unfortunately,
because of writing too much business and lacking expertise, many of these
captives became insolvent.
The insurance
market problems of the mid-1980s also spurred the creation of Risk Retention
Groups (RRGs) and the concept (also known as group or association captives)
became popular. RRGs are insurance companies established and capitalized
(funded) by a group of businesses to underwrite and insure their own collective
insurance risks. In addition, many trade associations formed and funded
association captives to underwrite and insure risks of the members of a
particular trade association.
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