Glossary of Captive Insurance & Risk Retention Terms
Admitted Reinsurance – Reinsurance provided by a reinsurer licensed or authorized in the jurisdiction in question. A company is “admitted” when it has been licensed and accepted by appropriate insurance governmental authorities of a state or country.
Arbitration Clause – A clause within a reinsurance agreement providing that if the ceding company and the reinsurer fail to agree, then they select neutral arbitrators with the authority to bind both parties to a solution. Resolving differences with out litigation.
Association Captive Insurance Company – A captive insurance company established by members of an association to underwrite their own collective risks. An association captive usually only insurers members of the sponsoring association.
Bordereau – A report providing premium or loss data with respect to identified specific risks, which is furnished the reinsurer by the reinsured. This report typically includes the insured’s name, premium basis, premium and the amount of coverage.
Burning Cost – The premium needed to cover losses based on historical experience for a proposed reinsurance agreement.
Cancellation – Run-off basis means that the liability of the reinsurer under policies, which became effective under the treaty prior to the cancellation date of such treaty, shall continue until the expiration date of each policy; Cut-off basis means that the liability of the reinsurer under policies, which became effective under the treaty prior to the cancellation date of such treaty, shall cease with respect to losses resulting from accidents taking place on and after said cancellation date. Usually the reinsurer will return to the company the unearned premium portfolio, unless the treaty is written on an earned premium basis.
Capacity – The largest amount of insurance an insurer or a reinsurer is willing and able to underwrite, including the amount they retain and the amounts for which they automatically bind their reinsurer.
Captive Insurance Company – A risk-financing method or form of self-insurance involving the establishment of a subsidiary corporation or association organized to write insurance. Captive insurance companies are formed to serve the insurance needs of the parent organization and to escape uncertainties of commercial insurance availability and cost. The insureds have a direct involvement and influence over the company’s major operations, including underwriting, claims, management policy, and investments.
Catastrophe Reinsurance – A form of reinsurance that provides coverage for losses resulting from a catastrophic event such as conflagration, earthquake or windstorm. Catastrophe loss generally refers to the total loss of an insurance company arising out of a single catastrophic event. These losses typically must exceed a specified amount and number of insurers and locations.
Cede – When a company transfers risk to another company.
Ceding Commission – An amount paid by a reinsurer to the ceding company to cover the ceding company’s acquisition and other expenses. The cedant’s acquisition costs and overhead expenses, taxes, licenses and fees, plus a fee representing a share of expected profits – sometimes expressed as a percentage of the gross reinsurance premium.
Ceding Company – The original or primary insurer; the insurance company that transfers its risk to a reinsurer.
Claims-Made Basis – A form of reinsurance under which the date of the claim report is deemed to be the date of the loss event. Claims reported during the term of the reinsurance agreement are therefore covered, regardless of when they occurred.
Commission – The primary insurance company usually pays the reinsurer its proportion of the gross premium it receives on a risk. The reinsurer then allows the company a ceding or direct commission allowance on such gross premium received, large enough to reimburse the company for the commission paid to its agents, plus taxes and its overhead. The amount of such allowance frequently determines profit or loss to the reinsurer.
Commutation – In the result of the termination of this contract, the Reinsurer shall be free from all further liability to the company for all loss and allocated loss expense not finally settled by the company as of the date of termination. In consideration of that release, the Reinsurer shall pay to the Company all amounts of loss and allocated loss expense due for losses finally settled.
Commutation Clause – A clause in a reinsurance agreement, which provides for estimation, payment and complete discharge of all future obligations for reinsurance losses incurred regardless of the continuing nature of certain losses.
Contingent Commissions – A payment to the ceding company in addition to the normal ceding commission allowance. It is a fixed percentage of the reinsurer’s net profits after a charge for the reinsurer’s overhead, derived from the subject treaty.
Contributing Excess – Where there is more than one reinsurer sharing a line of insurance on a risk in excess of a specified retention, each such reinsurer shall contribute towards any excess loss in proportion to his original participation in such risk.
Earned Premium – That part of the reinsurance premium calculated on a monthly, quarterly or annual basis, which is to be retained by the reinsurer, should there cession be canceled.
Errors and Omissions Clause – A provision in reinsurance agreements which is intended to neutralize any change in liability or benefits as a result of an inadvertent error by either party. To the extent possible the parties are placed in the position they would have been if the error had not occurred.
Ex Gratia Payment – A payment made for which the company is not liable under the terms of its policy. Usually made in lieu of incurring greater legal expenses in defending a claim.
Excess of Loss – Recoveries are available when a given loss exceeds the cedant’s retention defined in the agreement.
Expense Ratio – The percentage of premium used to pay all the costs of acquiring, writing and servicing insurance and reinsurance.
Experience – The loss record of an insured or of a class of coverage. Classified statistics of events connected with insurance, of outgo, or of income, actual or estimated. What figures show to have happened in the past.
Extra Contractual Obligations (ECO) – When used in reinsurance agreements, refers to damages awarded by a court against an insurer which go beyond the coverages of the insurance policy, typically due to the insurer’s bad faith, fraud, or gross negligence in the handling of a claim.
Facultative – Facultative reinsurance means reinsurance of individual risks by offer and acceptance wherein the reinsurer retains the “faculty” to accept or reject each risk offered. The reinsurer may specify its own ratings or terms for the reinsurance.
Federal Risk Retention Act – This act does not allow a state insurance regulator to prohibit risk retention groups domiciled in other states from operating within the regulator’s state, thus eliminating the need for a fronting company.
Financial Reinsurance – A form of reinsurance which considers the time value of money and has loss containment provisions, and is transacted primarily to achieve financial goals, such as capital management, tax planning, or the financing of acquisitions.
Flat Rate – A percentage rate applied to a ceding company’s premium writings for the classes of business reinsured to determine the reinsurance premiums to be paid the reinsurer.
Following the Fortunes – The clause stipulating that once a risk has been ceded by the reinsured, the reinsurer is bound by the same fate thereon as experienced by the ceding company.
Fronting – Most commonly refers to the practice of a non-admitted insurer (or an insured with a captive insurance company) contracting with a licensed insurer to issue an insurance policy for regulatory or certification purposes. This fronting insurer assumes little or no loss exposure; instead, financial arrangements are made to guarantee claims administration and payments. The fronting insurer is usually paid a percent of the premium.
Incurred Loss Ratio – The percentage of losses incurred to premiums earned.
Industrial Insured – An insured which procures the insurance of any risk or risks by use of the services of a full-time employee acting as an insurance manager or buyer and whose aggregate annual premiums for insurance on all risks total at least $25,000 and who has at least 25 full-time employees.
Industrial Insured Captive Insurance Company – Any company that insures risks of the industrial insureds that comprise the industrial insured group, and their affiliated companies.
Inflation Factor – A loading to provide for increased medical costs and loss payments in the future due to inflation.
Intermediary – A third party in the design, negotiation, and administration of a reinsurance agreement. Intermediaries recommend to ceding companies the type and amount of reinsurance to be purchased and negotiate the placement of coverage with reinsurers.
Intermediary Clause – A provision in reinsurance agreements, which identifies the intermediary negotiating the agreement. Most intermediary clauses shift all credit risk to reinsurers by providing that: the cedant’s payments to the intermediary are deemed payments to the reinsurer; and the reinsurer’s payments to the intermediary are not payments to the cedant until actually received by the cedant.
Layer – A horizontal segment of the liability insured.
Lead Reinsurer – The reinsurer who negotiates the terms, conditions, and premium rates and first signs on to the slip; reinsurers who subsequently sign on to the slip under those terms and conditions are considered following reinsurers.
Letter of Credit – A financial guaranty issued by a bank that permits the party to which it is issued to draw funds from the bank in the event of a valid unpaid claim against the other party.
Loss Adjustment Expense – All expenditures of an insurer associated with its adjustment, recording, and settlement of claims, other than the claim payment itself.
Loss Development – The difference between the original loss as originally reported to the reinsurer and its subsequent evaluation at a later date or at the time of its final disposal.
Loss Event – The total losses to the ceding company or to the reinsurer resulting from a single cause.
Loss Portfolio Transfer – The transfer of incurred losses to a third party. The assuming party hopes to profit by investing the sale price it has received over the length of time it requires to settle the claims it has assumed.
Loss Ratio – Proportionate relationship of incurred losses to earned premiums expressed as a percentage.
Non-Admitted Insurers – Insurance companies not licensed in a state may engage in business in the state if an admitted, properly filed company issues the policy and reinsures losses to the non-admitted reinsurer.
Non-Admitted Reinsurance – Reinsurance is non-admitted when placed in a non-admitted company and therefore may not be treated as an asset against reinsured losses or unearned premium reserves for insurance company accounting and statement purposes.
Non-Subscriber Workers’ Compensation Plan – A non-subscriber is an employee who elects, by filing appropriate notices required by state insurance authorities, to pay work-related injury loss through some method other than statutory workers’ compensation.
Occurrence – An adverse contingent accident or event neither expected nor intended from the point of view of the insured. With regard to limits on occurrences, property catastrophe reinsurance agreements frequently define adverse events having a common cause and sometimes within a specified time frame.
Offset Clause – A condition in reinsurance agreements which allows each party to net amounts due against those payable before making payment.
Participating or Pro Rata Reinsurance – Includes Quota Share, First Surplus, Second Surplus, and all other sharing forms of reinsurance where under the reinsurer participates pro rata in all losses and in all premiums.
Per Risk Excess Reinsurance – Retention and amount of reinsurance apply “per risk” rather than on a per accident or event or aggregate basis.
Peril – The causes of possible loss in the property field – for example: Fire, Windstorm, Collision, Hail, etc.
Policy Year – The year commencing with the effective date of the policy or with an anniversary of that date.
Pool – A group of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses, and expenses shared in agreed ratios. A method of allocating reinsurance among several reinsurers.
Pool – A joint underwriting operation of insurance or reinsurance in which the participants assume a fixed interest in all business written.
Portfolio Reinsurance – In transactions of reinsurance, it refers to all the risks of the reinsurance transaction.
Portfolio Run-off – Permitting premiums and losses in respect of in-force business to run to their normal expiration upon termination of a reinsurance treaty.
Premium (Written/Unearned/Earned) – Written premium is premium registered to an insurer or reinsurer at the time a policy is issued and paid for. Premium for a future exposure period is said to be unearned premium for an individual policy, written premium minus unearned premium equals earned premium.
Premium, Deposit – When the terms of a policy provide that the final earned premium be determined at some time after the policy itself has been written, companies may require tentative or deposit premiums at the beginning which are readjusted when the actual earned charge has been later determined.
Premium, Pure – The portion of the premium calculated to enable the insurer to pay losses and, allocated claim expenses or the premium arrived at by dividing losses by exposure and in which no loading has been added for commission, taxes, and expenses.
Professional Reinsurer – Reinsurers that offer reinsurance to other than affiliate companies. The majority of professional reinsurers provide complete reinsurance and service at one source directly to the ceding company.
Profit Commission – A provision found in some reinsurance agreements which provides for profit sharing. Parties agree to a formula for calculating profit, an allowance for the reinsurer’s expenses, and the cedant’s share of such profit after expenses.
Pure Captive Insurance Company – Any company that insures risks of its parent and affiliated companies.
Pure Premium – That portion of the premium which covers losses and related expenses, i.e. includes no loading for commissions, taxes, or other expenses.
Quota Share – The basic form of participating treaty whereby the reinsurer accepts a stated percentage of each and every risk within a defined category of business on a pro rata basis.
Reciprocal or Reciprocal Risk Retention Group – An unincorporated association; reciprocal insurance is that which results from an interchange among subscribers of reciprocal agreements of indemnity, the interchange being effectuated through an attorney-in-fact common to all subscribers.
Reinstatement Clause – When the amount of reinsurance coverage provided under a treaty is reduced by the payment of a reinsurance loss as the result of one catastrophe, the reinsurance cover is automatically reinstated usually by the payment of a reinstatement premium.
Reinstatement Premium – An additional premium paid to replenish the limit consumed in the event of a loss.
Reinsurance – The transfer of some or all of am insurance risk to another insurer. The company transferring the risk is the ceding company, and the company receiving the risk is the reinsurer.
Reinsurer – An insurance company that accepts the risk transferred from another insurance company in a reinsurance transaction.
Rent-a-Captive – Rent-a-Captives offer the benefits of a captive insurance company without the capitalization requirements, administrative costs and legal ramifications associated with establishing and operating an insurance subsidiary, and can return underwriting profits and investment income to a participant.
Retention – The net amount of risk which the ceding company or the reinsurer keeps for its own account.
Retrocession – A reinsurance of reinsurance. The transaction whereby a reinsurer cedes to another reinsurer all or part of the reinsurance it has previously assumed.
Retrospective Rating – A method which allows adjustment of the final reinsurance ceding commission or premium on the basis of the actual loss experience under the subject reinsurance treaty.
Retrospective Rating Plan – A method of establishing a premium on large commercial accounts. One in which the final premium is based on the insured’s actual loss experience during the policy term, subject to a minimum and maximum premium, with the final premium determined by a formula.
Risk Retention Group – A group self-insured program or group captive insurance company formed under provisions of the Liability Risk Retention Act of 1986, by or on behalf of businesses joined to insure their liability exposures. Such a group is exempt from most state laws, rules or regulations, except for the state in which it is domiciled.
Risks – A term used to denote the physical units of property at risk or the object of insurance protection and not Perils or Hazard. The word is also defined as chance of loss or uncertainty of loss.
Salvage and Subrogation – Those rights of the insured that, under the terms of the policy, automatically transfer to the insurer upon settlement of a loss. Salvage applies to any proceeds from the repaired, recovered, or scrapped property. Subrogation refers to the proceeds of negotiations or legal actions against negligent third parties and may apply to either property or casualty coverages.
Self-Insurance – Insuring yourself by setting aside money to cover possible losses rather than by purchasing an insurance policy.
Self-Insurance – The planned assumption of risk.
Sliding Scale Commission – A ceding commission, which varies inversely with the loss ratio under the reinsurance agreement.
Slip – A binder often including more than one reinsurer.
Special Acceptance – The facultative extension of a reinsurance treaty to embrace a risk not automatically included within its terms.
Sponsored Captive – A captive insurance company in which the minimum capital and surplus required by applicable law is provided by one or more sponsors, insures the risks of separate participants through the contract, and segregates each participant’s liability through one or more protected cells.
Spread Loss – A form of reinsurance under which premiums are paid during good years to build up a fund from which losses are recovered in bad years.
Stop Loss – A form of reinsurance under which the reinsurer pays some or all of a cedant’s aggregate retained losses in excess of a predetermined dollar amount or in excess of a percentage of premium.
Subject Premium – A cedant’s premiums to which the reinsurance premium rate is applied to calculate the reinsurance premium.
Surplus – The excess of assets over liabilities. Surplus determines an insurer’s or reinsurer’s ability to write business.
Surplus Share – A form of proportional reinsurance where the reinsurer assumes pro rata responsibility for only that portion of any risk, which exceeds the company’s traditional retentions.
Tax Reform Act of 1984 – One section of this act redefined income related to the insurance of US-based risks as US-source income instead of foreign-source income. Another section made income from the insurance of related risks in foreign countries taxable in the current year. The net effect of these two changes was to eliminate most tax advantages for an offshore single parent captive.
Tax Reform Act of 1988 – The major change imposed by this act affected offshore group captives in that the definition of a U.S. shareholder was changed from an ownership interest of 10 percent or more to any shareholding interest.
Treaty – The written contract defining the reinsurance agreement. The treaty contains provisions defining the terms of the agreement including specific risk definition, data on limits and retention, and provisions for premium payment and duration.
Ultimate Net Loss – The total sum which the assured, or any company as his insurer, or both, become obligated to pay either through adjudication or compromise, and usually includes hospital, medical and funeral charges and all sums paid as salaries, wages, compensation, fees, charges and law costs, premiums on attachment or appeal bonds, interest, expenses for doctors, lawyers, nurses, and investigators and other persons, and for litigation, settlement, adjustment and investigation of claims and suits which are paid as a consequence of the insured loss, excluding only the salaries of the assured’s or of any underlying insurer’s permanent employees.
Unearned Premium – That portion of the original premium that applies to the unexpired portion of risk.
Working Layer – The first layer above the cedant’s retention wherein moderate to heavy loss activity is expected by the cedant and reinsurer.