What is Captive Value Added (CVA)
Captive value-added refers to the financial benefits an organization could realize by creating a captive insurance company owned and operated by the parent organization.
Breaking Down Captive Value Added (CVA)
Captive value-added occurs when an organization’s captive insurance subsidiary generates profits for the controlling organization. A primary purpose in creating a captive insurance company is to insure the risks of the owners, while benefiting the parent organization from the captive insurer’s underwriting profits.
In terms of organizational structure, a company with one or more subsidiaries sets up a captive insurance company as a wholly-owned subsidiary. The captive insurer is capitalized and operates in a jurisdiction with captive-enabling legislation, allowing them to operate as a licensed insurer.
A captive insurance company provides a specialized form of insurance to its owners and participants, who often require less insurance coverage than the public. It is different from both self-insurance, which large organizations may use to finance some of their risks, and commercially available insurance, such as liability policies.
Captive programs are most often found within large organizations. This is due in part to their increased capacity to undertake captive value-added analysis, as they typically have more at stake when evaluating the opportunity impacts of a captive program on their total business. Larger organizations are also better able to absorb any insurance losses in a bad year.
Pros and Cons
By establishing a captive insurance company, the insureds choose to put their own capital at risk. Operating outside the traditional insurance industry means they can bypass regulations designed to protect the insureds, saving on those costs as a tradeoff.
Because the pool of insureds is confined within the total organization, risk-modeling tends to be simpler than in larger, more diverse, insurance risk pools. Modeling can help determine if a captive value-added is likely to be realized and how much profit is possible over several years.
Among all the models available for evaluating the potential financial risks of captive insurance, a popular one is the value of risk (VOR). This technique views the costs of risk in terms of how a particular risk can help the company complete its objectives. Value of risk looks at how shareholders and stakeholders will see their values impacted by the company taking on activities that are known to carry non-traditional risks.
The amount of risk depends on the type of business activity and the likelihood the company will be unable to recover costs, with the added knowledge that spending on one activity carries an opportunity cost. Opportunity cost is always an important factor when corporations consider how best to invest resources and capital in their futures. Many organizations attempt to maintain a strict strategic focus on the core business objectives and avoid being distracted by non-essential activities.
Similar to captive insurance is mutual insurance, where dividends are reinvested when profits are realized. Mutual insurance companies tend to accumulate rather than distribute their surplus, so creating a captive insurance subsidiary allows for profits to be distributed at the discretion of the owners.