In our last post about captives, we described a single-parent captive with a traditional fronting arrangement. In this post, we’ll address the use of a captive in conjunction with a large deductible primary casualty program.
First, it’s important to understand the mechanics of a large deductible program. With this approach, Old Republic Insurance Company issues Workers’ Compensation, Auto Liability, and General Liability policies that contain large, per claim deductibles to our insured, and responds to claims on the same basis as policies with no deductibles. The claim process for the injured worker in the case of Workers’ Compensation, or the injured person or owner of damaged property in the case of Auto or General Liability, is essentially unchanged, with the claims being paid by Old Republic on behalf of the insured. Old Republic’s policyholder (Client), however, agrees to reimburse Old Republic for losses within the agreed deductibles. Old Republic requires security, typically in the form of a Letter of Credit, from the Client for expected ultimate losses within the deductibles to secure their deductible obligations.
You may recall from our last post on this topic that a captive insurance company (Captive) is formed by a non-insurance company (Client) to insure the risks of the parent company. So how can the Client use the Captive in conjunction with the large deductible policies described above? While we’re not a party to the transaction, we understand that in some cases the Captive issues a Deductible Reimbursement Policy to the Client to achieve the objective of funding retained losses via the Captive. The premium is agreed to between the Client and the Captive and is based on an actuarial estimate of the expected losses, and ALAE if applicable, within the deductibles of the large deductible policies issued by Old Republic. The Deductible Reimbursement Policy premium may also include provisions for captive expenses and profitability depending on the Client’s goals for the Captive and other activity within the Captive. With this type of arrangement, when Old Republic bills the Client for losses within the deductibles, the Client in turn makes a claim to the Captive under the Deductible Reimbursement policy. The Captive pays the Client, who in turn pays Old Republic. Here, as in our previous post, we’ve described the basic contractual obligations, but in practice, simpler cash flow and funding arrangements may be made.
Because this approach typically reduces frictional costs when compared to a traditional captive reinsurance arrangement, it is a common arrangement today where the Client desires to make use of a Captive to fund primary casualty losses.