Risk management is an important part of governance planning for every business. Often, risk management means transferring risk to a third-party through the purchase of insurance. Recently, the Alberta Legislature created a different risk management option, which will allow companies to arrange insurance through related, purpose-built Alberta insurance companies which they own either directly or indirectly.
The Captive Insurance Companies Act (CICA), has received Royal Assent and will come into force on Proclamation. The regulations, which will set out the details of how Alberta captive insurance companies will be formed, regulated and operated are expected in spring 2022 (Regulations). Alberta is the second province to introduce such legislation, after British Columbia.
What are Captive Insurers?
A captive insurance company—or simply a "captive"—is an 'in-house' or private insurance company created to underwrite the risks of its owners and participants. Traditionally, captives have insured the risks of a single entity or of a larger corporate structure of related entities. The CICAalso appears to expand on these categories by allowing groups of otherwise unrelated entities to form a captive, so long as certain requirements are met.
Forming a captive gives a company greater control over the risks it faces. Along with saving premiums paid to third-party insurers, insuring through a captive may offer savings by encouraging loss control and reducing operating costs. A captive may also be a source of revenue through returns on investment, should those not be needed to fund losses and, depending on the nature of the captive, through the premiums paid to the captive. Finally, a captive can provide bespoke coverage to suit the needs of the insured.
To establish a captive, a company needs to raise and maintain adequate base and operating capital, and that capital is at risk in the event of losses. In addition, a captive insurer operates as an independent company and will incur operating costs, besides potentially incurring losses due to claims. Insuring through a captive may also allow less flexibility in terms of changing insurance arrangements once they are in place.
Key Features of the CICA
Formation of Captive Insurance Companies
The CICA requires Alberta captives to have their principal place of business in Alberta. Alberta captive insurance companies must be corporations under the Alberta Business Corporations Act, or limited partnerships under Alberta's Partnership Act, so long as the sole general partner is an Alberta corporation.
To obtain a license, a captive needs to establish to the satisfaction of the regulator that it has sufficient base and operating capital, with the requisite amount to be established by the Regulations.
The CICA establishes different types of captives: pure captives; association captives; and sophisticated captives. Other types of captives may be authorized by the Regulations.
The differences between pure, association and sophisticated captives lie not in what they can insure, but in who can be insured. Any captive can undertake any class of insurance, as long as appropriate licensing is in place, but the 'market' for that insurance varies.
A pure captive can only offer insurance to its parents, affiliated companies, officers, directors, employees and independent contractors when they are acting on behalf of the parent and/or its affiliates.
In contrast, an association captive can underwrite the risks of its association (the group that owns an association captive), the member organizations of the association and their affiliated entities, as well as officers, directors, employees, agents of the association, its members and their affiliates and independent contractors when acting on behalf of any of these entities.
A sophisticated captive is much like an association in terms of the scope of its insurance market, but insures the risks of a group of "sophisticated insureds." Whether an entity is a "sophisticated insured" depends on whether the regulator accepts that it has expertise in insurance matters and on whether it incurs a threshold amount for annual premiums for insurance, with that amount to be established by the Regulations.
Regulation of Captive Insurance Companies
In some ways, captives will operate like traditional insurers. For example, in Alberta a captive may seek a license to underwrite any of the classes of insurance established through the Insurance Act. Like a traditional insurer, a captive may only undertake classes of insurance for which it holds a license.
The investment activities of captives will also be regulated. Captives will generally be in control of their own investments, so long as they comply with prudent investment standards as defined in the CICA. Directors of captives must establish policies and procedures to ensure the captive adheres to prudent investment standards. The responsible minister retains a discretionary power to prohibit or limit a captive's investments and to direct a captive to divest itself of investments if there is a concern about capital adequacy or liquidity.
Finally, it will be an offence to contravene certain sections of the CICA and the Regulations, and certain directions or orders of the responsible minister under those enactments.
Is Insuring Through a Captive Right For You?
Whether insuring through a captive insurance company is right for your business depends on the types of risk your company faces and on its risk tolerance. It also depends on whether the cost of transferring that risk through traditional insurance is greater, in strictly financial terms or based on an overall analysis of the value of the benefits gained through establishing a captive, than the cost of establishing and maintaining a captive insurer.