There are many ways that MNE groups may manage risks within the group. For example, they may choose to set aside funds in reserves, pre-fund potential future losses, self-insure, acquire insurance from third parties or simply elect to retain the specific risk. In some other cases an MNE group may choose to consolidate certain risks through a so-called “captive” insurance.

In this guidance, the term captive insurance is intended to refer to an insurance undertaking or entity substantially all of whose insurance business is to provide insurance policies for risks of entities of the MNE group to which it belongs.

In contrast, in this guidance the term reinsurance refers to a reinsurance undertaking or entity the purpose of which is to provide reinsurance policies for risks of unrelated parties that are in the first instance insured by entities of the MNE group to which it belongs.5 (The situation in which risks of entities within an MNE group are insured in the first instance by an unrelated party but then reinsured by an entity within the MNE group is discussed in Section E.2.4).

Captive insurances may be subject to regulation in the same way as other insurance and reinsurance companies. The precise requirements of insurance regulation will vary from one jurisdiction to the next but typically include certain actuarial, accounting and capital requirements. While insurance regulation is intended to protect policyholders, local regulators may impose a lighter regulatory regime where the captive insurance provides insurance exclusively to members of the MNE group.

There are multiple reasons for an MNE group to use a captive insurance such as: to stabilise premiums paid by entities within the MNE group; to benefit from tax and regulatory arbitrage; gaining access to reinsurance markets; mitigating the volatility of market capacity; or because the MNE group considers that retaining the risk within the group is more cost effective.

Another possible reason for the use of a captive insurance by an MNE group in addition to those listed is the difficulty or impossibility of getting insurance coverage for certain risks. Where such risks are insured by a captive insurance this may raise questions as to whether an arm’s length price can be determined and the commercial rationality of such an arrangement (see Section D.2 of Chapter I).