Regulation and Reporting
Captives are generally subject to less regulation than conventional insurance companies although it is normally felt that all captive insurers should be subject to insurance regulation, even 'pure' captives which underwrite only the risks of their parent company.
The purpose of insurance regulation is to protect policyholders (who are in most captives also the shareholder), investors and other stakeholders through the provision of tools provided to ensure that companies operate in accordance with acceptable standards of corporate governance, financial strength and market conduct. This in turn promotes efficient, safe, fair and stable insurance markets, which encourage growth and competition in the sector.
In applying insurance regulations to captives, regulators may adopt a risk-based approach, which takes account of both the nature of the captive insurance market and the form of the individual captive. For example the risk posed by a captive that only underwrites the property risks of a single parent without recourse to reinsurance is little different from the risk posed by retaining the risks on the parent’s balance sheet. On the other hand a captive, which is significantly exposed to risk from unrelated business, is no different from a normal commercial insurer. While the owner/captive relationship permits the owner to exercise significant influence over its captive, it is important that the captive practices good corporate governance to ensure that the captive continues to meet its solvency requirements and maintains adequate technical provisions. Even if no third party risks are involved, pure captives often undertake transactions with fronting companies and reinsurers who benefit from and often require the security provided by proper licensing and regulation.
The application of appropriate regulation reduces the risk that a captive may become involved in fraudulent activities or be used as a vehicle for money laundering. Even though a captive may not underwrite unrelated party risks, there could still be an impact on stakeholders if a failure of the captive deprived the parent of funds to meet valid claims, for example in respect of public liability risks. In addition, without regulation, it would not be possible to impose minimum capital requirements or reserving standards.
Captive insurance is in addition an alternate form of capacity available to finance commercially uninsurable risks, or risks that are otherwise retained. The establishment of the captive requires investment of capital to support the taking of risk. When underwriting profits are retained in the captive, rather than distributed, then additional capacity is created. If captives fail, capacity is likely to be reduced, because future captive owners and users will be less likely to invest capital in order to finance their risk in a captive. Confidence in the integrity of the captive mechanism needs to be maintained in order to ensure availability of this extremely important source of alternative capacity.
