Notes on Captives

Captives

Disadvantages of a Captive

* Capitalization and commitment - Establishing a captive insurance company requires a substantial amount of initial capital to ensure that the captive remains financially healthy during tumultuous times. Rent-a-captives mitigate capital outlays but typically require long-term participation to make it worth the while.

* Internal administrative costs - Establishing a captive insurance company requires time and resources of relevant internal personnel.

* Dependency on service providers - The quality of service that a captive offers depends on the quality of third-party service providers that it utilizes.

* Potential for inadequate loss reserves - When actual losses exceed initially expected levels, captive insurance companies might need additional funds to be allocated. If risks are not well-assessed initially, the captive owner could suffer adverse financial consequences.

* Taxation - The IRS has progressively implemented stringent tax policies over time that have reduced much of the tax benefits originally enjoyed by captive owners.

* Increased cost/reduced availability of other insurance - Although captive insurance can provide excellent solutions for particular lines of coverage, it can cause other lines to increase in price if favorable coverages are shifted to the captive and unfavorable coverages are left in the commercial market

1. Raising Capital

* Because the entity is essentially self-insured, it needs to raise a substantial amount of capital to keep in reserve to pay for claims. If the entity underestimates its need for protection, or experiences a catastrophic loss, it may not have the funds on hand to provide adequate coverage. This could have a severe impact on the company's bottom line if it needs to draw from other assets.

Quality of Service

* When choosing captive insurance, an entity may not have the expertise in selecting third-party service providers or may choose...