A captive insurance company is where a parent group creates its own licensed insurance company to provide coverage for itself. The benefits of this include reduced costs, ability to insure difficult risks, direct access to reinsurance markets, and increased cash flow. In addition, 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. Over 90% of Fortune 1000 companies have their own captive insurance companies.
The term ‘captive’ was coined by the ‘father of captive insurance’, Frederic M. Reiss, while he was bringing his concept into practice for his first client, the Youngstown Sheet & Tube Company, in Ohio in the 1950s. When Reiss helped the company incorporate its own insurance subsidiaries, they were called captive insurance companies because they wrote insurance exclusively for the captive mines.
Most captive insurance companies are based in tax havens, with Bermuda being the world's leading offshore captive domicile, and Luxembourg the largest reinsurance captive domicile. The onshore regulatory burden and the cost of operating either a U.S.-based or Lloyd's-based captive drove the captive insurance companies offshore in the 1960s. Bermuda was attractive due to its geographical location, clean reputation, and status as a British Dependent Territory (which eliminates the risks and uncertainties of operating in politically unstable jurisdictions).
Captive insurance policies can be designed so that the risks they insure are so unlikely that the captives will never pay out a claim. The insurance premiums will be deductible to the subsidiary companies operating in tax paying countries, but the premiums will be tax free to the captive insurance companies (domiciled in tax havens).