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In: Operations Management

Objective: demonstrate knowledge in captive insurers, in relation to enterprise risk management. You are the risk...

Objective: demonstrate knowledge in captive insurers, in relation to enterprise risk management.

You are the risk manager of for Paymore ShoeSource, a large, publicly traded, and expensive shoe store chain. Your boss tells you that you that Paymore is planning to set up a broad insurance captive. Overhearing the conversation, a coworker who is not familiar with captives interrupts the conversation with a number of questions. Please answer the following questions for the coworker.

Generally, why would a large company such as Paymore (that is assumed to be risk neutral) purchase insurance?

What is an insurance captive?

Why might the company want to insure through a captive rather than through a traditional insurer? List two reasons.

a)

b)

What is the structure of a “broad” captive? Please use a diagram to illustrate your answer.

Based on the structure just described, does a broad captive represent a contract of insurance defined by the IRS? Discuss the requirements of an insurance contract and argue whether or not a broad captive meets these requirements.

Expert Solution

Answer 1:

Insurance captive is an insurance company that is wholly controlled by its insureds, who are also the owner of this insurance company. In other words it is the fully owned insurance subsidiary that is meant to protect the parent company from risks that might occur.

Answer 2:

The company might want to insure through a captive rather than through a traditional insurer for following two reasons:

Captive insurance provides flexibility needed that is designed as per the requirement of its parent company for migrating risks and achieving risk financing goals. This feature is not present in traditional insurer programs.
The other reason is that by creating captive insurance a company like Paymore ShoeSource can reduce their cost as well as increase cash flow as well as it saves tax to large extent. The company can also have direct access to reinsurance markets.

Answer 3:

Earlier it was identified by IRS that maximum small captive insurers use it for tax saving purpose. Now by making use of its disclosure tool IRS transaction of interest, IRS demands captive insurers to disclose details of insurance transaction.

The insurance contract requires the details about what are the risk that need to be covered, and other details like premiums.

keosha answered 1 year ago

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