Professor Joe Zou and 張倩倩
5 November 2025
Nowadays, enterprises frequently face a dilemma in risk management and insurance. On the one hand, they are exposed to increasingly complex and numerous risks, from natural disasters and environmental liabilities to cybersecurity threats and supply-chain disruptions, which pose a constant threat to business operations and financial stability. Although enterprises can purchase commercial insurance to mitigate risks, they often encounter various constraints, including high premiums, limited coverage, and lack of access to insurance. On the other hand, they incur considerable annual premiums, yet the probability of filing claims is low and damages awarded are limited, resulting in a significant impact on cash flow.
Against such a backdrop, setting up captive insurance companies to manage corporate risks is becoming more and more popular. A captive insurance company is a wholly-owned subsidiary established by one non-insurance company or a group of non-insurance companies to provide insurance coverage for a single parent company or joint-parent companies.
British Petroleum (BP) recorded average accounting profits of approximately US$2 billion and assets of over US$50 billion between 1987 and 1991. In the decade preceding 1991, the company paid premiums totalling US$1.15 billion for coverage of asset losses ranging from US$10 million to US$500 million, but received damages of merely US$250 million, which can only be described as a losing deal.
As a matter of fact, given the limited overall impact of medium accident-related losses, BP has decided to substantially reduce its external commercial insurance coverage and instead manage these losses through the establishment of captive insurance companies. Currently, BP owns two captive insurers, i.e. Saturn and Jupiter. The latter, headquartered in Guernsey, provides reinsurance coverage for the former and underwrites asset loss, business interruption, and other risks. Headquartered in Vermont, USA, Saturn offers insurance coverage for specific risks such as workplace injuries and terrorist attacks.
Historical background
Captive insurance originated in the mid-20th century. In 1958, Frederic M. Reiss, an insurance broker, introduced the concept of “single-client insurance company” and coined the term “captive insurer”. He started up a captive insurance company in Bermuda, laying the foundation for the captive insurance industry through stringent risk control and a reinsurance mechanism (see Note 1).
The Bermuda Monetary Authority came into operation in 1969 as a regulator for captive insurance. During the 1970s, the power and nuclear energy sectors took the lead in gradually setting up mutual captive insurers. The year 1981 saw the pioneering passage of the Vermont Captive Legislation, paving the way for the State of Vermont to eventually become America’s captive insurance centre. In 1986, the US Federal Government passed the Risk Retention Act to permit the establishment of captive insurance companies to address legal liability risks between 1984 and 1986.
Development milestones
The hard market in each insurance market cycle would serve to facilitate the expansion of captive insurance. This phenomenon is often attributable to a surge in premiums in the aftermath of huge losses in the insurance sector, which lead to inadequate underwriting capacity. Between the end of 1984 and 1986, the hard market conditions in the liability insurance sector were a particularly notable example, prompting the then six largest accounting firms to establish their own captive insurers to secure audit liability coverage. Mutual captive insurance companies were also formed by American hospitals and doctors to offer medical malpractice liability insurance at lower costs.
According to statistics from Captive.com, the number of captive insurance companies worldwide, which stood at approximately 2,200 in 1986, rose to a peak of 6,939 in 2015 before slightly dropping to 6,290 in 2024. Newton Media’s data shows that as of 2024, the world’s top five captive insurance centres were the State of Vermont in the US (with 683 registered captive insurers), Bermuda (632), Cayman Islands (561), the State of Utah in the US (370), and the State of Delaware in the US (331). Between 2000 and 2016, approximately 35% of S&P 500 companies owned captive insurance companies (see Note 2). Today, captive insurance companies operate across all sectors (see Note 3), and as of 2023, their premiums accounted for a quarter of total global commercial insurance premiums.
Strategic considerations
First of all, development of captive insurance companies is primarily aimed at reducing cash outflows. Take BP mentioned above for example. The company faces a significant disparity between huge annual premiums it pays and the insurance compensation it receives. By setting up its own captive insurer to provide the necessary coverage, the company can retain the premiums that would otherwise be paid externally. In the event of actual losses lower than expected, the surplus premiums accumulated can be allocated to operating surplus. This approach helps to smooth insurance costs and optimize the cash flow structure.
Second, setting up a captive insurance company is conducive to lowering insurance costs. Commercial insurance is typically priced based on the insurer’s overall risk pool, which blends low- and high-risk exposures to calculate an average premium. Given that insurers cannot ascertain each client’s true risk level, it is essential for them to factor in a safety margin in their pricing to guard against adverse selection by high-risks clients. As a result, even clients with sound risk management and low claim rates have to bear part of the costs incurred by high-risk clients. Captive insurance companies enable low-risk companies to avoid paying premiums higher than their actual risk level.
Furthermore, while the pricing of commercial insurance also reflects the moral hazard arising among some policyholders after purchasing coverage, moral hazard is very limited in captive insurance. Captive insurance premiums not only more accurately reflect the real risks of companies, but also encourage companies to continuously optimize internal risk controls and lower insurance expenditure. Using a captive insurer also allows a company to avoid the profit loading added by commercial insurance providers.
In terms of tax treatment, captive insurance is also preferable to pure risk retention. Without insurance coverage, a company can only write off losses from taxable income after they occur. Through captive insurance arrangements, the premiums paid can be treated as tax-deductible insurance expenses in accordance with tax regulations. By reducing taxable income earlier, the company benefits from the time value of cash flows.
In addition, unlike buying commercial insurance, establishing a captive insurer affords businesses direct access to the reinsurance market to transfer excess or extreme risks. Companies can also set their own risk retention ratios or cede surplus risks to the reinsurance market. This not only makes risk management more flexible but also enables companies to spread catastrophe risks globally by taking advantage of the highly competitive pricing available in the reinsurance market.
Finally, apart from helping to cut costs, establishing a captive insurer can fill coverage gaps in the commercial insurance market, e.g. risks related to terrorist attacks or strikes. Even when such coverage is available, the premiums are often prohibitively high. The emergence of captive insurance companies facilitates business for these “gap” risks. For instance, the Nuclear Mutual Limited was created by nuclear energy companies in the US to provide coverage for nuclear risks that the commercial insurance market cannot underwrite.
Hence, forming a captive insurance company serves as both an insurance arrangement and a financial and risk management strategy. It allows companies to mitigate cash outflows, lower insurance costs, and cover risks beyond the scope of traditional protection. As they grow in scale, captive insurance companies have even begun working with external clients, evolving into a new source of profit.
The evolution of regulation
America’s captive insurance sector is subject to a series of rules and regulations as well as increasingly stringent regulatory oversight. The 1986 Tax Reform Act imposes restrictions on premium deductions and tax arbitrage practices, requires companies to enhance the professionalism and compliance of their captive operations, and prompts some companies to establish captive insurers in offshore jurisdictions to obtain more predictable tax treatment. In 2002, the US Internal Revenue Service stipulates that captive insurance companies must meet risk distribution and risk transfer requirements, i.e. only captive insurers with legitimate insurance functions are eligible for relevant tax incentives.
In 2014, the US Foreign Account Tax Compliance Act requires foreign financial institutions (including captive insurance companies) to report relevant accounts to the US Internal Revenue Service, pushing up compliance costs of captive insurance overseas and prompting some companies to establish their captive insurers in the US. In 2024, Section 831(b) of the US Internal Revenue Code further tighten the eligibility threshold for tax incentives for small captive insurers to prevent tax credit abuse (see Note 4).
In Europe, regulation of captive insurance is the responsibility of individual member states of the Eurozone. Many countries permit captive insurance, and the overall trend is to encourage its development through legislation and to enhance the attractiveness of the jurisdiction as a captive insurance domicile. In addition to Luxemburg, Guernsey, the Isle of Man, Ireland, and Switzerland―where the captive insurance market is more developed―France passed legislation in June 2023, granting approval for the establishment of captive insurance companies, and in November the same year amended its tax rules to offer them tax incentives.
As a pioneer founder of the modern insurance system, the UK is gearing up to embrace captive insurance companies to reinforce its position as an international insurance centre (see Note 5). Next week, we will continue to examine the potential risks and constraints in relation to the establishment of captive insurance companies, with a focus on the opportunities and challenges for Hong Kong in its pursuit of becoming an international captive insurance centre.
Note 1: Anastopoulo, Constance A. “Taking No Prisoners: Captive Insurance as an Alternative to Traditional or Commercial Insurance.” Ohio State Entrepreneurial Business Law Journal, vol. 8, no. 2, 2013, pp. 209–231.
Note 2: Chang, Mu-Sheng, and Jiun-Lin Chen. “Characteristics of S&P 500 Companies with Captive Insurance Subsidiaries.” Journal of Insurance Regulation, vol. 37, no. 2, 2018, pp. 1–28. National Association of Insurance Commissioners.
Note 3: Hepfer, Bradford, Jaron H. Wilde, and Ryan J. Wilson. “Nontax Use of Tax Havens: Evidence from Captive Insurance.” Available at SSRN 4942068 (2025).
Note 4: Rosenbaum, Hugh, Jack Gibson and Bonnie Rogers. “A Changing Captive Landscape.” 2025. Captive.com, International Risk Management Institute, Inc., www.captive.com/captives-101/history-of-captives/a-changing-captive-landscape.
