Are captives cost-effective mechanisms for managing risk?
Captive expense ratios are lower than those of commercial insurers when the captive writes on a direct basis. The use of a fronting company eliminates the differential. The real cost reduction comes from using a captive to control cash flow and increase an insureds willingness and ability to retain more risk. Using captives enables the insured to share in underwriting results and cash flow benefits. In addition, having a captive available can result in commercial insurance reductions simply because of price competition. Lastly, captives enable unbundling of costs usually included in the premium, such as inspections and other policies. Unbundling services reduces premium taxes paid by the insured. What about taxes? The captive form of insurance may provide a tax benefit to the parent firm. Contributions to a self-insurance pool are not recognized by the IRS to be tax-deductible business expenses, although the actual losses are deducible as they are paid. Premium payments to an insurer a
