There are various ways to structure a captive.

Single-owner captives, as the name suggests, are set up and operated by a single owner to insure the owner's risks and the risks of its subsidiaries and affiliates. Single-owner captives insure the risks of the owner—sometimes referred to as a "pure captive"—or they may be able to provide coverage to other entities as well.
Group captives, in contrast, are owned by multiple, non-related entities. Typically, group captives insure similar types of risk (think energy or health companies operating in the same industries). Group captives may also be able to provide coverage for entities other than those affiliated with the owners.
A rental captive, or rent-a-captive, is a captive insurer that is not owned by a policyholder but rather by a broker, reinsurer or fronting insurance company. Essentially, in a rental captive structure, the captive insurer creates a separate set of books for each insured to account for the insured's individual risks and contributions. While rental captives can require less initial capital than a single-owner or group captive, they may offer less flexibility.
Protected cell companies are a special kind of rental captives. Also known as segregated portfolio companies or segregated account companies, protected cell companies allow for the segregation of accounts so that each account may be legally protected from the liabilities of other accounts within the captive. Each protected cell operates as an independent cell within the captive's larger structure.

Benefits and drawbacks of using captives

While each type of captive has its own advantages and disadvantages, all captives share some common advantages.

Insuring the uninsurable. Captives can provide policyholders with alternative coverage options and limits that are unavailable or too expensive in the traditional insurance market.
Customized coverage. Compared to traditional insurance markets, captives may also provide policyholders more flexibility to customize coverage, eliminating the need to pay for a package of additional coverages that the insured does not need or want.
Tax benefits. In addition, premiums paid to the captive may be tax deductible, and surplus premiums not used to pay claims stay with the company, rather than flowing to third-party insurers. Moreover, captives can invest money set aside to pay claims, and the profits of those investments can flow back to the owner of the captive.

Although the advantages discussed above make captives attractive in some situations, there are also disadvantages that must be considered.

Upfront costs. As an initial matter, captives can require significant effort, time and expense to set up. Set up costs include conducting a feasibility study, selecting the captive's domicile, securing state regulatory approval, assessing risk exposure of the insured(s), forming a corporate structure and agreeing upon the terms of insurance, among other things. Additionally, the captive must be adequately funded to handle claims once coverage begins.
Disputed claims. Despite the alignment between captives and the companies that own them, captive arrangements may not eliminate disputes with traditional insurance companies because some programs involving captive insurance still use traditional insurance. For instance, the captive may purchase reinsurance from traditional insurers. Also, a captive may issue the primary insurance policy and the policyholder may purchase excess insurance from traditional insurers.
Claim frequency and severity. Captives are often used for high-frequency, low-severity risks that provide fulsome data and are more predictable. This allows actuarial modeling to more accurately predict future losses (and corresponding funding requirements) with higher degrees of certainty. Predictability is critical for captives and their owners because the captive needs to be funded with adequate capital to respond to potential losses should a claim arise.

The kinds of coverages that typically fit into this model are workers' compensation, general liability or products liability. Directors and officers liability claims, in contrast, are usually low-frequency and high-severity, which may complicate modeling and predictability in creating and funding a captive for D&O risks. Companies evaluating captive arrangements should take these factors into account in deciding whether to depart from traditional insurance markets.

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Structure, benefits and potential pitfalls of captive insurance

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