Why you should consider a captive insurance company

There are many reasons why a company would form a captive, some of which are discussed below.

The primary reason being able to obtain insurance not available in the commercial insurance market at a cost that is deemed to be reasonable.

Second, the insured is able to obtain more control over the insurance policy through better service for its insurance exposure; loss control, underwriting and more control over the handling and settlement of claims.

Third, a captive provides significant opportunity for cost reduction by eliminating the selling and marketing expense overhead passed on to the insured by a third party insurance company

Fourth, in a pure captive the insured should be able to increase the corporate family’s cash flow since the payment stays within the same corporate family.  The main benefit in this scenario being that corporate family keeps the cash and is able to further invest it rather than pay to a third party outside of the corporate family, giving up the investment earnings.  While the insured can deduct the insurance payment as a legitimate business expense the insurance premium is generally taxable income to the captive.  Thus, if the parent and captive elect to file as an affiliated group, the premium becomes part of the affiliated group’s income and has a zero impact on the taxable income of the group.

Fifth, the insured can use its own loss experience in determining insurance rates without factoring in the general population’s loss experience rates.  Of course, this is only a benefit if there is a good loss experience (low or normal claims).  This can also vary depending on the type of insurance policy, for example worker’s compensation and health insurance require large populations of employees in order to lower the risk profile.  However, other types of insurance such as loss of business income and property & casualty will provide an easier mechanism for cost control.  By using its own loss experience and implementing cost control programs the insured can, in large part, control and stabilize their premium costs.

Sixth, captives can be used as wealth transfer vehicles.  For example, a company owned by a high net worth individual establishes a captive with written premiums higher than $350,000 and lower than $1.2 million.  Through a special exemption in the Internal Revenue Code (IRC) for this level of premiums the captive is taxed only on its taxable investment income and not on the gross premiums received from the insured.  The estate’s beneficiaries are shareholders of the captive instead of the insured, preferably through a trust so as to protect the shares from future creditor’s claims.  The beneficiaries receive the benefit of increased share prices caused by an increase in the captive’s overall net worth.  However, the captive is subject to a lower level of taxation because of the special exemption noted above.  There are also other unique tax attributes of insurance companies that allow it to accumulate assets and act as a wealth transfer vehicle.

Seventh, a captive may give the insured direct access to the reinsurance market providing for lower costs of operation and regulatory barriers, along with lower administration expenses.

Eighth, a captive may provide the insured with an additional negotiating tool when dealing with third party insurers because they are not in dire need of insurance.

Despite its obvious benefits, a captive may not be appropriate for everyone because of the various costs and regulatory issues that must be addressed.  Some of these are discussed below.  These factors are neither all inclusive nor exclusive, meaning if you do not have one of these factors you may still benefit from a captive.  Only a feasibility study can provide a more definitive answer.

For most types of captives, there are some general characteristics that indicate a company is a good candidate for a captive. 

  1. An above-average or unusual risk profile (insurable risks).
  2. The ability to leave the assets in the captive for an extended period of time, a minimum of 7 years but ideally 10 years.  This allow for a sufficient period of time to benefit from the growth of the investments inside the captive.
  3. The insured, or insured group, should have the financial resources to contribute at least $250,000 in annual premiums.

For a pure captive the insured should have at least two of the following:

  1. at least $1.5 million in top-line revenue;
  2. $250,000 or more in “self-insured or uninsured business risk”;
  3. 100 or more employees; or
  4. $500,000 or more in annual commercial insurance expenses.

Please contact us for more information on captive insurance programs and to see if your situation warrants implementation.

As required by U.S. Treasury Regulations governing tax practice, you are hereby advised that any written tax advice contained herein was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding tax penalties that may be imposed under the Internal Revenue Code

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