Captive Insurance Definition & Glossary


Captive Insurance Definition, Terms and GlossaryBelow, you will find commonly used captive insurance definitions, terms and glossary used by the experts in the industry.  We have positioned these terms alphabetically to make it easy for you to find exactly what you're looking for. It's the perfect  glossary for anyone looking for relevant, accurate information.

Actuary Admitted Insurer Aggregate Excess of Loss Reinsurance
Aggregate Limit of Liability Alien Insurer Alternative Market
Association Captive Attachment Point Automatic Treaty
Best’s Rating Bordereau Bornhuetter-Ferguson Technique
Break Point Brokerage Market Buffer Layer
Captive Insurer Catastrophic Loss Catastrophic Reinsurance
Cedant Ceding Commission Claims Reserve
Combined Ratio Contingent Commission Credibility
Deductible Dividend Domicile
Earned Premium Earned Surplus Enterprise Risk Management
Excess Insurance Excess of Loss Reinsurance Expected Loss
Experience Ratio Exposure Facultative Obligatory Treaty
Facultative Reinsurance Feasibility Study Foreign Insurer
Frequency Fronting Hard Market
Incurred But Not Reported (IBNR) Incurred Losses Insurance Department
Investment Income Judgment Rates Large Deductible Plan
Law of Large Numbers Letter of Credit Loss Adjustment Expense
Loss Development Loss Forecasting Loss Portfolio Transfer
Loss Ratio Loss Reserve Loss Trending
Actual Loss Sustained Business Income Extra Expense
Leader Property Interruption by Civil or Military Authority Coverage


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Actuary: An individual, often holding a professional designation, who computes statistics relating to insurance. Actuaries are most frequently used to estimate loss reserves (for both insurers and self-insureds) and to determine premiums for various coverage lines. Professional designations are awarded by the Casualty Actuarial Society and the Society of Actuaries.

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Admitted Insurer: An insurance company licensed to do business in a specified jurisdiction to underwrite insurance in that jurisdiction.

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Aggregate Excess of Loss Reinsurance: A form of reinsurance that requires participation by the reinsurer when aggregate excess losses for the primary insurer exceed a certain stated retention level.

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Aggregate Limit of Liability: An insurance contract provision limiting the maximum liability of an insurer for a series of losses in a given time period, e.g., a year or for the entire period of the contract. Aggregate limits may be equal to or greater than the per occurrence or per accident policy limit. An insurance policy may have one or more aggregate limits. For example, the standard commercial general liability policy has two: the general aggregate that applies to all claims except those that fall in the products-completed operations hazard and a separate products-completed operations aggregate.

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Alien Insurer: An insurer domiciled outside the United States.

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Alternative Market: A term commonly used in risk financing to refer to one of a number of risk funding techniques (e.g., self-insurance, captive) or facilities (e.g., ACE, XL) that provide coverages or services outside the realm of those provided by most traditional property and casualty insurers. The alternative market may be utilized by large corporations, for example, to provide high limits of coverage over a large self-insured retention. It may also be utilized by groups of smaller entities, for example, participating in a risk retention group or group captive program. Note that the distinction between traditional and alternative markets tends to blur over time as many traditional insurers have expanded their offering of products to encompass alternative-type funding techniques, and vice versa. Finally, retrospective funding plans, especially paid loss plans, are sometimes identified with the alternative market.

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Association Captive: A captive insurance company formed and owned by a trade or professional association.

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Attachment Point: The point at which excess insurance or reinsurance limits apply. For example, a captive's retention may be $250,000. This is the attachment point at which excess reinsurance limits would apply.

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Automatic Treaty: A reinsurance treaty under which the ceding company must transfer exposures of a defined class that the reinsurer must accept in accordance with the terms of the treaty.

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Best's Rating: The rating system developed and published annually by A.M. Best Company that indicates the financial condition of insurance companies.

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Bordereau: A report providing premium or loss data with respect to identified specific risks. This report is periodically furnished to a reinsurer by the ceding insurers or reinsurers.

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Bornhuetter-Ferguson Technique: An actuarial technique for developing losses to estimate their ultimate amount. An amount for expected unreported losses (derived using the reciprocal of the loss development factor) is added to the actual reported losses to obtain the estimated ultimate loss for a given accident year. The technique is most useful when actual reported losses for an accident year are a poor indicator of future IBNR for the same accident year, as is often the case where there is low frequency of loss but a very high potential severity.

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Break Point: The loss level at which losses below the level are considered "primary" losses and losses above are "excess" losses. The appropriate break point in any risk financing program is a matter of judgment and is dependent upon that program's individual characteristics.

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Brokerage Market: Reinsurers that write business through reinsurance intermediaries. Reinsurers that do not generally accept such business are referred to as the direct market.

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Buffer Layer: Any layer of insurance (or risk retention) that resides between the primary (burning) layer and the excess layers. For example, if the insured's primary CGL limit is $500,000 and its umbrella attachment point is $1 million, the layer of $500,000 excess of $500,000 coverage between the two is the buffer layer.

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Captive Insurer: A captive insurer is an insurance company that insures the risks of an associated business. For example, a parent corporation may own both an operating company and a captive insurance company as brother-sister subsidiaries where the captive insures risks of the operating company; such as for illustration: ABC Parent Corporation owns both ABC Manufacturing Company and ABC Captive Insurance Company and ABC Captive Insurance Company insures certain of the risks of ABC Manufacturing Company. This arrangement is often called a single-owner captive. There are many other forms of captive. As an example of an alternative arrangement, a captive may be owned by a number of unrelated companies in the same industry and insure a set of risks unique or common to that group of companies. This form of captive is often referred to as an association captive (meaning that it insures a specific industry or trade group). There are many more ways of classifying captives by type, e.g., pure captives (those that write no outside business) and so on.

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Catastrophic Loss: Loss in excess of the working layer, usually of such magnitude as to be difficult to predict and therefore rarely self-insured or retained.

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Catastrophic Reinsurance: A form of reinsurance that indemnifies the ceding company for the accumulation of losses in excess of a stated sum arising from a single catastrophic event or series of events.

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Cedant: A ceding insurer or reinsurer. A ceding insurer is an insurer that underwrites and issues an original, primary policy to an insured and contractually transfers (cedes) a portion of the risk to a reinsurer. A ceding reinsurer is a reinsurer that in turn transfers (cedes) a portion of its reinsurance layer to a retrocessionnaire.

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Ceding Commission: A percentage of the reinsurance premium retained by a ceding company to cover its acquisition costs, and sometimes, to provide a profit.

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Claims Reserve: An amount of money set aside to meet future payments associated with claims incurred but not yet settled at the time of a given date.

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Combined Ratio: The sum of two ratios, loss and expense, calculated by dividing incurred losses and all other expenses by earned premiums. Used in both insurance and reinsurance, a combined ratio below 100 percent indicates an underwriting profit.

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Contingent Commission: In reinsurance, an allowance payable to the ceding company in addition to the normal ceding commission allowance. It is a predetermined percentage of the reinsurer's net profits after a charge for the reinsurer's overhead, derived from the subject treaty.

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Credibility: An actuarial term describing the degree of accuracy in forecasting future events based on statistical reporting of past events. Credibility tends to increase with the number of exposure bases in the observed data and to decrease with higher levels of variability in the observed data.

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Deductible: An amount agreed to between the insured and insurer whereby the insured reimburses the insurer for losses it pays within the specified deductible amount.

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Dividend: The return of premium to an insured by the insurance company. Policies on which dividends may be paid are often called participating insurance. It is important to note that it is illegal for insurers to guarantee that dividends will be paid.

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Domicile: The location or venue in which a captive insurer is licensed to do business. Some factors to be considered in selecting the best domicile for a given captive include capitalization and surplus requirements, investment restrictions, income and local taxes, formation costs, acceptance by fronting insurers and reinsurers, availability of banking and other services, and proximity considerations.

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Earned Premium: An insurer "earns" a portion of a policy's premium as time elapses during the policy period.

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Earned Surplus: Funds earned by an insurance company (including captives and risk retention groups) after all losses and expenses have been paid. Once earned surplus is recognized, it can be allocated to capital and/or dividends.

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Enterprise Risk Management: A risk management approach that totally integrates both financial (i.e., speculative) and event (i.e., pure) risk into one broad program of multiple retentions and high-excess aggregate insurance limits. To date, however, few firms have implemented such a comprehensive program. Nevertheless, companies are increasingly buying multiyear, multiline insurance programs that cover disparate forms of risk (e.g., property and directors and officers liability), which are designed to maximize the benefits of portfolio diversification.

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Excess Insurance: A policy or bond covering the insured against certain hazards, and applying only to loss or damage in excess of a stated amount, a specified primary limit, or a self-insurance limit. It is also that portion of the amount insured that exceeds the amount retained by an entity for its own account. See next line.

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Excess of Loss Reinsurance: A form of reinsurance that indemnifies the ceding company against the amount of loss excess of only the specified retention.

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Expected Loss: Estimated loss frequency multiplied by estimated loss severity, summed for all exposures. This measure of loss generally refers to the total losses of an organization of a particular type, e.g., workers compensation or general liability.

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Experience Ratio: Describes any plan that uses the past loss experience and exposure levels, e.g., payrolls, of the individual risk as a basis of determining premiums.

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Exposure: The state of being subject to loss because of some hazard or contingency. Also used as a measure of the rating units or the premium base of a risk.

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Facultative Obligatory Treaty: The hybrid of the facultative versus treaty reinsurance approach. It is a treaty under which the primary insurer has the option to cede or not cede individual risks. However, the reinsurer must accept any risks that are ceded.

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Facultative Reinsurance: Reinsurance of individual risks on an individual "offer" and "acceptance" basis wherein the reinsurer has the option to accept or reject each risk offered.

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Feasibility Study: A study undertaken to determine whether a contemplated risk financing program is practicable for an organization or group of organizations. An actuarial analysis is often performed in conjunction with a feasibility study. The term is often used in reference to studies that attempt to ascertain whether or not the formation of a captive insurance company is a viable risk financing option under a given set of circumstances.

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Foreign Insurer: An insurer domiciled in the United States but outside the state in which the insurance is to be written.

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Frequency: The likelihood that a loss will occur. Expressed as low frequency (meaning that the loss event is possible but the event has not happened in the past and is not likely to occur in the future), moderate frequency (meaning the loss event has happened once in a while and can be expected to occur sometime in the future), or high frequency (meaning the loss event happens regularly and can be expected to occur regularly in the future). Workers compensation losses normally have a high frequency as do automobile collision losses. General liability losses are usually of a moderate frequency, and property losses often have a low frequency.

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Fronting: The process whereby an insurance company issues an insurance policy to the insured and then reinsures all or most of the risk with the insured's captive insurance company or elsewhere as directed by the insured. This approach allows the insured to issue certificates of insurance acceptable to regulators and lenders and avoids the burden of licensing the insured's captive in all states or of becoming a qualified self-insurer in all states.

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Hard Market: One side of the market cycle that is characterized by high rates, low limits, and restricted coverage. Contrasts with a soft market.

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Incurred But Not Reported (IBNR): Recognition that events have taken place in such a manner as to eventually produce claims but that these events have not yet been reported. In other words, IBNR is a loss that has happened but is not known about. Since it is impossible to know the value of a case not yet reported or investigated, a subjective estimate is often used by insurance companies to recognize losses incurred but not reported.

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Incurred Losses: All open and closed claims occurring within a fixed period, usually a year. Incurred losses include reserves for open claims but do not usually include IBNR losses.

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Insurance Department: A regulatory department charged with the administration of insurance laws and other responsibilities associated with insurance. The commissioner of insurance is the head of this department in most states.

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Investment Income: The income of an insurance company derived from its investments, as opposed to its underwriting operations. The term has special significance in the insurance industry as various factions consider whether such income should be considered in ratemaking.

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Judgment Rates: Rates that are established by judgment of an underwriter rather than by a rating authority. Judgment rates are used most often for those lines of insurance in which there are not enough similar exposure units to develop statistically credible rates.

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Large Deductible Plan: An Insurance program that allows the insured to retain a portion of each loss through a substantial deductible and to transfer to an insurer losses in excess of that deductible. The insurer typically handles losses falling below the deductible and bills these costs back to the insured.

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Law of Large Numbers: A tool used in probability and statistics. The larger the number of units independently exposed to loss, the more accurate the ability to predict loss results arising from those exposure units.

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Letter of Credit: A legal commitment issued by a bank or other entity stating that, upon receipt of certain documents, the bank will pay against drafts meeting the terms of the letter of credit. Letters of credit are frequently used for risk financing purposes to collateralize monies owed by an insured under various cash flow programs such as incurred but not paid losses in a paid loss retrospective rating program. "LOCs" also provide a means of meeting capitalization requirements of captives, and are used to satisfy the security requirements in "fronted" deductible or retention programs.

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Loss Adjustment Expense: The cost of investigating and adjusting losses. Such expenses may be termed "allocated loss adjustment expenses (ALAE)" or unallocated loss adjustment expenses.

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Loss Development: The difference between the original loss as first reported to an insurer and its subsequent evaluation at a later date or at the time of its final disposal.

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Loss Forecasting: Predicting future losses through an analysis of past losses.

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Loss Portfolio Transfer: A financial reinsurance transaction in which loss obligations that are already incurred and will ultimately be paid are ceded to a reinsurer.

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Loss Ratio: Proportionate relationship of incurred losses to earned premiums expressed as a percentage. If, for example, a firm pays a $100,000 annual premium for worker's compensation insurance, and its insurer pays and reserves $50,000 in claims, its loss ratio is 50 percent ($50,000/$100,000).

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Loss Reserve: An estimate of the value of a claim or group of claims not yet paid. A case reserve is an estimate of the amount for which a particular claim will ultimately be settled or adjudicated. An insurer will also set reserves for its entire books of business to estimate its future liabilities.

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Loss Trending: One step in the process of predicting future losses, through an analysis of past losses.

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Actual Loss Sustained: Coverage applies to the “actual loss sustained” by the insured as a result of a covered loss.

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Business Income: The net income (net profit or loss before income taxes) that would have been earned by the insured if a loss hadn’t occurred, as well as the numerical value of the insured’s regular operating expenses.
Contingent Business Interruption (CBI) coverage: This covers an insured's income loss resulting from covered losses experienced by an entity which the insured relies upon, i.e. suppliers, manufacturers, distributors.

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Extra Expense: The expenses incurred by the insured during the period of restoration. These would not have been necessary if there had been no physical loss to real or personal property caused by a covered loss. Example: Temporary business equipment rentals.

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Leader Property: Otherwise known as an “attraction property,” a leader property is not owned, controlled, or operated by the insured. Instead, it attracts customers to an insured’s place of business. Example: A souvenir shop located next to a museum, selling museum-related merchandise.

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Interruption by Civil or Military Authority Coverage: Provided for the insured’s actual loss incurred during the length of time when access to real or personal property is prohibited by order of civil authority. Example: The surrounding area of the business is labeled a “crime scene,” and ordered to be closed off by local law enforcement.

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