The potential positive effects of captive insurance companies on efficiency and moral hazard within a group of companies

Abstract

Captive insurance companies are ‘in-house’ (re)insurance companies formed with the specific objective of insuring the risks of their parent company and/or its affiliated companies. This alternative form of risk management is potentially or in fact an efficient means through which large listed or a group of companies other companies or a group of companies can protect themselves financially. In the process, the parent company has more control over how risks are insured and claims are managed. The parent company also has more insight into and is able to exercise more influence on the behaviour of the insured companies and their affiliates and therefore on the insured risks, as a result of which moral hazard is lower. There’s also a positive influence on the problem of adverse selection. Insurance law and regulatory legislation, to which captives are also subject, also play an important role in the mitigation of moral hazard. An insurance captive can have important efficiency effects, but is not suitable for every company. The company to be insured must have sufficient financial buffers and a serious premium volume for a captive to be able to increase the prosperity of a company. The start-up costs are high, there are operational costs and the captive must comply with the same regulatory and financial requirements as regular insurance or reinsurance companies. European insurance regulatory legislation is very strict for direct writing captives, but this does benefit the quality of the captives and the risk management policy pursued and prevents captives from being misused.