(Re)Insurance Captives, Efficiency and Moral Hazard: An Attractive Manner of Risk Financing and Risk Management for Companies in Certain Circumstances

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 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. Whereas the popularity of insurance captives has increased in the past few years, there is still a distinct lack of clarity regarding the precise significance of an insurance captive, the advantages and disadvantages thereof, and the effects for risk management and risk financing. This contribution is intended to provide more clarity and to demonstrate that under certain circumstances an insurance captive can have important efficiency effects and, among other things, a positive effect on moral hazard. Insurance law and regulatory legislation, to which captives are also subject, also play an important role in the mitigation of moral hazard.