In the past, talk about property risk in a captive “used to kill off projects. You didn't want to attract a lot of frictional costs to the transaction, and there is not a lot to gain from accelerating a tax reduction for a property loss,” he said.

A property loss, Mr. Koral explained, “either happens or it doesn't.” The loss generally is paid off in 24 months, which means accelerating the tax deduction for loss reserves “will not be worth a lot compared to the frictional costs, premium tax, [and costs of] operating and setting up the captive.”

However, setting up a captive for property losses can greatly benefit a corporation with subsidiaries, he noted. If a corporation decides to take “all property losses up to $5 million per occurrence, that might not sell very well in Peoria,” he said, explaining that “people in the subsidiaries might fear a big loss could wipe out their bonus.”

Unbeknownst to the corporate risk management department, the subsidiary might call a local insurance broker, “and you might find a fill-in policy that is on a subsidiary-specific basis for some premium amount that will never be disclosed or discussed with corporate,” he said. “Imagine an organization that has dozens of subsidiaries, and imagine that conversation taking place dozens of times.”

The captive serves as both a carrot and a stick for subsidiaries, he said. “The stick is we'll make you take a big deductible,” while the carrot is, “we'll also sell you some internal insurance that will allow you to deal with your own [profit and loss] issues” on a local basis.

Mr. Koral continued that a captive can also be used to manage a large deductible, “particularly in a market where the deductible is going up faster than you can manage with your own subsidiary.”

Rather than simply “being a postman or a messenger,” if the insurance market raises a deductible from $1 million to $5 million, for example, with a captive, “I have a chance to break that link,” he said.

The risk manager can deal with the insurance market and determine a “corporate deductible based upon what the overall corporate risk retention need is,” Mr. Koral said. The risk manager can also work with the subsidiaries to help determine their individual risk retention needs. The captive, meanwhile, serves as “the shock absorber that sits in the middle,” he explained.

While the captive might not have an identifiable dollar value, it has managerial value to the extent that “you can avoid your subsidiaries wasting corporate money by dressing up their own P&Ls and buying local insurance policies,” he emphasized.

Robert Storey, vice president at Munich-American RiskPartners in Princeton, N.J., said that using a captive for property risks gives an organization direct access to reinsurance. “Historically, reinsurers haven't had much contact with insurance buyers,” he said. “To access us, you had to go through an insurance company. But with captives that has changed.”

What are the benefits of direct access to reinsurance? “We find that captives are often asked by their owners to look and act like a big insurance company, even though they're not,” Mr. Storey explained. “Reinsurance can help you do that.”

Reinsurers can achieve this by helping increase large-line capacity, increase premium capacity, stabilize loss experience, and reduce volatility “in the form of catastrophe relief for orderly withdrawal of business.” They also provide underwriting expertise, he said.

Mr. Storey said that there normally are restrictions and regulations limiting the maximum amount of insurance a captive can write. The limit, he said, is typically 10 percent of surplus.

The captive's ability to write large accounts where the 10 percent of surplus restriction applies, however, would limit them to small accounts or small shares of large accounts, he added.

There are also jurisdictional limits on the premium a captive can write, he said. In meeting premium-to-surplus ratio requirements, “the net premium is used in the calculation, meaning that reinsurance would have the same benefit as the large-line capacity,” Mr. Storey said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 16, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.