Conditions for Captive Insurer Value: A Monte Carlo Simulation

Abstract:     
We construct two potential scenarios to depict the cash flows from the operation of a captive insurer. We then use Monte Carlo simulation to identify conditions that are sustainable in practice and under which captives have a high probability of creating positive shareholder value. We use realistic value ranges for both a class 1 Bermuda captive and a British Virgin Islands (BVI) general captive. On average, captives have a low probability of generating shareholder value. This outcome is consistent with much of the literature regarding captives. Well-managed captives, however, have an extremely high probability of generating value for their shareholders - even without favorable tax treatment. A well-managed captive is incorporated in the least costly captive jurisdiction during a soft insurance market, but remains dormant until a hard insurance market. The parent self-manages the captive's operations and uses non-cash assets to satisfy the captive's regulatory capital requirements while dormant; the captive calls for little reinsurance. Captives of parents with low systematic risk have the highest probability of generating shareholder value even when the captive invests conservatively.

Number of Pages in PDF File: 26

Keywords: Captives, value, simulation

JEL Classification: G22, E17

Accepted Paper Series