Case Reserve Insurance
What a case reserve represents, how the first estimate is set, and why it moves every time new information reaches the file.
Glossary
Captive Insurance
An insurer owned by the businesses it covers, the forms it takes, and what separates a captive from simply retaining the risk.
Captive insurance is an arrangement in which an organization, or a group of organizations, uses an insurance company established primarily to insure its own risks. The insurer is called a captive because its business is connected to the needs of its owners or participants.
In the simplest structure, a company owns an insurance subsidiary that provides coverage to the parent and related businesses. The captive collects premiums, estimates its claim obligations, pays covered losses, and maintains the capital required to operate. NAIC’s overview of captive insurance companies.
How captive insurance works
A captive turns a decision to retain risk into a formal insurance operation. The owner decides which exposures the captive should cover and which should remain with commercial insurers or other arrangements.
The captive then operates under an approved business plan and insurance license in its domicile, the jurisdiction where it is established and primarily supervised. Coverage may be written directly where permitted or received through reinsurance from another insurer.
Premiums finance the expected claims and operating costs. Capital provides additional financial resources to support uncertainty and meet regulatory requirements. These serve different purposes: paying an annual premium does not remove the need for sufficient capital.
At the corporate-group level, placing risk in a wholly owned captive generally keeps that risk within the group unless it is transferred onward. Moving the insurance obligation into a subsidiary does not make the underlying exposure disappear.
Types of captive arrangements
Single-parent captive
A single-parent, or pure, captive principally insures the risks of its parent and associated companies. It gives the owner a dedicated insurer for the agreed program.
For example, a manufacturing group might use one captive to cover specified retained property and liability exposures across its subsidiaries.
Group or association captive
A group captive serves participating organizations that share an insurance arrangement. An association captive is connected to members of an association. Ownership, participation, and sharing of losses depend on the structure and agreements.
The arrangement can pool experience and operating costs across members, while requiring governance over which risks are accepted and how adverse results are funded.
Sponsored or protected-cell arrangement
A sponsored captive can provide an existing insurance structure in which participants use separate cells. Applicable law and contracts determine how a cell’s assets and liabilities are separated from other cells and the sponsor’s general account.
Vermont’s guidance, for example, addresses segregation, participant contracts, and regulatory approval of protected cells. A cell arrangement therefore needs to be understood through its actual legal structure, rather than treated as equivalent to owning a standalone insurer. Vermont’s protected-cell captive guidance.
Why organizations form captives
The reasons often concern control and availability of insurance. An owner may want coverage tailored to its operations, a more consistent approach to retained risks, or a way to combine exposures across several businesses.
A captive can also give the organization more direct visibility into claims, expenses, and the financial consequences of risk prevention. It may purchase reinsurance to limit particular exposures or protect against adverse outcomes.
Commercial-market conditions can influence the decision. A business facing higher deductibles or reduced availability may explore financing part of the risk itself. That does not establish that a captive is automatically cheaper: formation, administration, capital, and claims all have costs.
AIG describes captives as vehicles for risk financing and retention, with potential uses including coverage gaps and access to reinsurance. AIG’s introduction to captive insurance.
A captive insurance example
Consider a fictional company using a wholly owned captive for a defined layer of liability risk. The following simplified annual results assume all premium is earned in the year. Investment income, tax, and reinsurance are excluded.
| Item | Expected year | Adverse year |
|---|---|---|
| Earned premium | $1,200,000 | $1,200,000 |
| Incurred claims | $800,000 | $1,400,000 |
| Operating expenses | $200,000 | $200,000 |
| Underwriting result | $200,000 profit | $400,000 loss |
Incurred claims include payments and changes in unpaid claim estimates. They are not limited to the cash paid before year-end.
In the expected year, premium exceeds claims and expenses by $200,000. In the adverse year, the captive needs resources to absorb the $400,000 underwriting loss. Its owner remains economically exposed to that result.
The example shows why captive planning includes adverse scenarios. A favorable projection alone does not establish adequate funding. Vermont’s financial-projection guidance specifically requires expected and adverse scenarios in relevant captive submissions. Vermont’s guidance on captive financial projections.
Direct insurance, fronting, and reinsurance
A captive’s permitted activities depend on its license and the location and type of risk. Where direct issuance is unsuitable or unavailable, a fronting insurer may issue the policy and reinsure the agreed exposure to the captive.
In that structure, the fronting insurer is the policyholder’s insurer. The captive has a separate obligation under the reinsurance contract. AIG describes this use of fronting to connect captive risk retention with local issuing requirements. AIG’s fronting and captive services.
The captive can also buy its own reinsurance. For instance, it might retain a defined amount per loss and purchase protection above that amount, subject to an agreed limit. This separates the decision to operate a captive from the decision about how much risk it should keep.
How a captive differs from ordinary self-insurance
An organization can retain risk without creating an insurer, for example through a deductible or a self-insured arrangement where permitted. A captive adds a licensed insurance entity, contractual coverage, governance, reserving, and reporting obligations.
It also differs from a captive insurance agent. A captive agent usually represents one insurer or insurance group. That distribution relationship does not mean the agent owns a captive insurance company.
A U.S. risk retention group is another distinct structure: it is a member-owned liability insurer operating under the federal Liability Risk Retention Act and applicable state rules. Some are formed under captive legislation, but the terms are not interchangeable. NAIC’s explanation of risk retention groups.
What running a captive requires
The organization needs a credible assessment of its exposures, premiums, expected losses, adverse scenarios, and ongoing expenses. Management must also arrange claims handling, accounting, actuarial work, investment oversight, and regulatory reporting.
Reliable policy and claims records support that work. A policy administration system can maintain the coverages and transactions, while finance and actuarial processes use those records to measure obligations and results.
The financial benefit depends on actual experience over time. Distributions to owners remain subject to the captive’s obligations and applicable requirements, and tax treatment depends on the structure and jurisdiction. The defining feature is the organized financing of the owners’ insurance risks through an insurance company.
