A company that provides risk-mitigation services for its parent company. A captive insurance company may be formed if the parent company is unable to find an outside firm to insure against a particular business risk; if the parent company determines that the premiums it pays to the captive insurance company are sufficiently deductible; or that the insurance the captive insurance company provides is more affordable or offers better coverage.
Whether the parent company will be able to see a tax break from the creation of a captive insurance company depends on the classification of insurance company transactions. The IRS requires risk distribution and risk shifting to be present in order for a transaction to be considered "insurance".
While there are financial benefits to creating a separate entity to provide insurance services, parent companies must also weigh the personnel cost of a captive insurance company. Some types of risk that the captive company might insure against could result in larger expenses than the parent company can afford, and can lead to bankruptcy. Larger private insurers are less likely to be bankrupted by a single event because of a diversified pool of risk.