How a non-insurance company can manage its risks: the solution, becoming its own insurer

The insurance market is not always willing to take on certain risks, and when some companies do accept them, the cost of such coverage can be extremely high. This is one of the reasons why companies decide to establish a captive. Typically, multinational companies, which face very complex and specific risks for which standard commercial coverage is insufficient, and which allocate a large part of their budget to insurance, are the ones that create captives.

The most significant advantage of a captive is the ability to design insurance products tailored individually to the group’s needs, specifically for the risks it faces—whether due to the market it operates in or the type of activity it undertakes.

Along with this advantage comes the ability to modify the company’s internal insurance program, adjusting coverages, adding new policies, or increasing indemnity limits, for example. In short, a captive can adapt to any changes, reducing its exposure to market fluctuations and optimizing its retention and the costs involved in financing risk.

Setting up a captive doesn’t happen overnight. It’s not just about fulfilling certain formalities, such as administrative authorizations; it also involves meeting significant financial requirements. During the first few years of creating a captive, the financial capital committed to covering all related expenses is considerable. Lastly, but not least, competent and qualified professionals are essential for a captive to function properly. The insurance industry is highly specialized, and knowing how to quantify risks, establish premiums, and operate with international insurance programs is not something just anyone can do.

A captive can manage all of a company’s risks or just a portion of them. However, for decades, it has become an ally of major multinational corporations, which now have more powerful risk management departments but still rely on traditional insurers to ensure they are protected no matter what happens.

So, what role does a traditional insurer play in this setup? A traditional insurer becomes a necessary party to issue policies in direct insurance and transfer them to the captive. This also relieves the captive of the need to maintain licenses in every country where operations are carried out.

The policy is issued by the insurer, and all or part of the risk is transferred to the captive. Naturally, the traditional insurer charges a percentage of the premiums issued for these services since, formally, the insurer assumes legal responsibility, even if the captive (which is supposed to share the risk) fails to meet its obligations. In these cases, insurers include protection clauses to ensure that the parent company of the captive steps in if the captive does not respond.

Therefore, insurance companies offer market knowledge, capacity, and financial solvency, allowing captives to achieve their intended goals. Not many global insurers work with captives, so a long-term, trusted commercial relationship between the parties is key for this type of business.

In fact, MAPFRE Global Risks, which specializes in large risks, is one of the companies that works with captives as long as it participates in the risk. Aerospace, oil, and energy companies are insured by MAPFRE Global Risks, and these types of multinational companies are among the most likely to create a captive. Currently, MAPFRE Global Risks works with over 30 captives, supporting them in their development, and for this, it has a dedicated team that strengthens this business line, generating around 600 million euros in revenue last year. Good claims statistics, appropriate pricing, customer proximity, risk participation, market knowledge, and sector expertise are all crucial to developing this business. A captive can achieve this, but not from the start. Here, the know-how of a traditional insurer is a key strength.

While the essence of captives remains the same, different types can be distinguished based on the market in which they operate (i.e., direct insurance or reinsurance) or where they are located. We can distinguish between domestic captives (those located in the country where the risks originate or where the parent company is based) and offshore captives (those located outside the country of the parent company). Offshore captives are more common, as setup costs are lower, and the processes to establish them are faster. Captives can also be classified by size: small or large scale, depending on the risk they are willing to retain.

They can also be differentiated based on the origin of the risks they accept:

• Pure captive: This type solely covers the risks of the parent company or the entire group it belongs to. It does not insure risks from any other company outside its corporate conglomerate.

• Mutual captive: Several companies with homogeneous risks create a captive to cover them. This ensures the collective risks of the members of a certain industry, i.e., risks that affect all members equally. For example, coverage for frost damage to a specific crop in a given area. This risk impacts all companies cultivating the same crop in the same region, regardless of size or whether they export.

• Associative captive: Similar to the previous one, this type assumes the individual risks of each member of the association. Unlike the mutual captive, it takes individual risks into account, even if only one member is affected. The risk is mutualized, and this model is most similar to a conventional insurance company.

These are just a few classifications of captives, but many more could be established.

A captive is an option for large companies or corporate conglomerates, but it requires the support of a traditional insurer with international presence and experience with insurance programs to develop its activities. We’ve described how it works in broad terms, but it’s not as simple as it sounds. Highly qualified professionals, actuarial techniques, and years of experience back the experts working in this field.

RELATED ARTICLES: