Allow Captive Insurance To Guard Your Business

Captive insurance is a type of insurance that offers protection to the business world. This business oriented insurance can be set up to protect just about any business from potential risk. Captive manager is not exclusive to one form of business but offers multiple policies.

Some of the forms of captive insurance out there include: single parent captive, agency captive, group or associative captive, and more. The most used type of captive is the single parent captive. Each captive is extremely flexible and varies based on the needs of a specific business. There might be many risks in your business and consulting with a captive insurance manager is a great start to identify them all. Once all risks are identified your captive insurance manager will be able to set up a captive plan that caters specifically to your business’s security.

Captive manager can be much more useful for many businesses and industries than traditional insurance types. Captives tend to be much cheaper to maintain than other kinds of business insurance. Furthermore, unlike standard insurance coverage, captives help to protect buyers from unneeded coverage. A captive manger will help business owners to set up a plan that is solely based on need. This is a big part of the reason that businesses are turning to captive coverage as a part of their risk management needs.

Some businesses find that obtaining traditional types of insurance is very difficult when compared to captive insurance. This is due in part to the extremely high premiums of traditional risk insurance. Other troubles with standard business insurance are that the standards for acceptance have become extremely high, making it difficult for many business to even qualify for a policy. Some businesses have risks that are so unusual; no traditional insurance company offers coverage for these risks.

Claims are another reason that company managers are looking to captives. Captive insurance provides exceptional claim service. This is because of the fact that this type of insurance is normally in house. Claims are processed rapidly thanks to lack of extra requirements that in house operations provide.

No matter what insurance your business requires captive can give you the protection you need. Because of this, insurance costs are much lower, and operations run a lot easier. The tailor made style of a captive also helps to provide unique businesses with exactly the type of risk protection required to operate within their industry.

Captive Insurance – Beginners Guide For Small or Medium Size Business Owners (You Can Save Money!)

Captive insurance companies used to only be for large, multi-billion corporations. Times have changed, and as business owners’ risk management needs have become more complex, more and more mid-size companies are taking the captive plunge. Read more to see if a captive insurance company is right for you.

Why Use a Captive Insurance Company?
You may be considering setting up a captive insurance company and it’s very likely you may be saying to yourself, “why should I be doing this?” There are lots of good reasons – and you have probably heard most of them – but the main reason for setting up a captive is… To make money.

How can a captive make me money?
A captive gives you the ability to share in underwriting profit and investment income which can lower your company’s insurance cost. A captive can provide income tax benefits because premium ceded to a captive is tax-deductible, while underwriting profits and investment income are tax-deferred. Assets placed into a captive are shielded from creditors other than claimants if set up properly. A captive can be an invaluable estate planning tool. Assets put into a trust can be excluded from your taxable estate.

A captive is not for everyone.

Who is a captive for?

  • You need to take a long term view toward risk management.
  • You strongly believe in loss prevention.
  • You have a willingness to share risk.
  • You need at least $1,000,000 of annual insurance premiums.
  • You should have $500,000 or more of pre-tax corporate profits.

Who is a captive not for?

  • You buy insurance to “win” against your insurer.
  • You are not interested in loss control or prevention.
  • You are risk averse.
  • Your insurance premiums are not big enough.
  • Your assets are not sufficient to provide the necessary collateral.

How do I set one up?

First you need to choose a jurisdiction where your captive will be domiciled. It can be onshore in one of the many states that have favorable regulations, or it can offshore in such places as Bermuda, Cayman Islands or Barbados. These are the components of a captive start-up:

  • Feasibility study
  • Business plan
  • Actuarial study
  • Application fees
  • Capital investment
  • Collateral
  • Captive manager

The Rent-a-Captive Option

If you want an easier, less expensive way to get into the captive business, you might want to consider using a rent-a-captive. A rent-a-captive is a specific type of captive set up to provide all of the benefits of an owned captive insurance company, without the upfront costs, capital investment and annual maintenance costs. You “rent” a protected/segregated cell, working capital, and licenses from an insurance company set up for this purpose. There is no pooling of risk between cells – each cell, and its assets, are legally separated from the others.

What is the 831(b) Election?

The Internal Revenue Codes section 831 applies to the taxation of insurance companies other than life insurance companies. Subsection (b) applies to the tax treatment of small insurance companies, which are defined as writing $1,200,000 or less in annual written premium. This tax election exempts underwriting profits from tax, and the captive pays tax only on investment income. This tax election can be used for an offshore captive as long as you elect to pay U.S. Tax. You should consult your tax advisor if you think this could work for you.

What is Collateral?

Collateral is needed if the captive insurance company is used as a reinsurer of an admitted insurance company, and is needed so the insurance company can take credit for the reinsurance in their financial statements. The collateral protects the insurance company from any credit risk of the captive’s performance. Five types of collateral are acceptable: Letters of Credit; parental guarantee; pledged assets; performance bond and insurance trust.

Is There an Exit Strategy?

Risk management strategies evolve over time and at some stage, the owners of a captive insurance company may look for an exit strategy. Here are three options for exiting from a captive insurance arrangement:

  • Commutation. The fronting insurance company agrees to assume all outstanding liabilities of the captive. This may allow the release of collateral.
  • Novation. A reinsurer agrees to step in the place of the captive and assume the remaining outstanding liabilities of the captive.
  • Reinsurance. The captive enters into a contract with a new reinsurer to assume the remaining outstanding liabilities of the captive. This option works for insurance that was fronted by an admitted insurer as well as for insurance policies issued directly by the captive.

Captive Insurance Company – Reduce Taxes and Build Wealth

For business owners paying taxes in the United States, captive insurance companies reduce taxes, build wealth and improve insurance protection. A captive insurance company (CIC) is similar in many ways to any other insurance company. It is referred to as “captive” because it generally provides insurance to one or more related operating businesses. With captive insurance, premiums paid by a business are retained in the same “economic family”, instead of being paid to an outsider.

Two key tax benefits enable a structure containing a CIC to build wealth efficiently: (1) insurance premiums paid by a business to the CIC are tax deductible; and (2) under IRC § 831(b), the CIC receives up to $1.2 million of premium payments annually income-tax-free. In other words, a business owner can shift taxable income out of an operating business into the low-tax captive insurer. An 831(b) CIC pays taxes only on income from its investments. The “dividends received deduction” under IRC § 243 provides additional tax efficiency for dividends received from its corporate stock investments.

Starting about 60 years ago, the first captive insurance companies were formed by large corporations to provide insurance that was either too expensive or unavailable in the conventional insurance market.

Over the years, a combination of US tax laws, court cases and IRS rulings has clearly defined the steps and procedures required for the establishment and operation of a CIC by one or more business owners or professionals.

To qualify as an insurance company for tax purposes, a captive insurance company must satisfy “risk shifting” and “risk distribution” requirements. This is easily done through routine CIC planning. The insurance provided by a CIC must really be insurance, that is, a genuine risk of loss must be shifted from the premium-paying operating business to the CIC that insures the risk.

In addition to tax benefits, principal advantages of a CIC include increased control and increased flexibility, which improve insurance protection and lower cost. With conventional insurance, an outside carrier typically dictates all aspects of a policy. Often, certain risks cannot be insured conventionally, or can only be insured at a prohibitive price. Conventional insurance rates are often volatile and unpredictable, and conventional insurers are prone to deny valid claims by exaggerating petty technicalities. Also, although business insurance premiums are generally deductible, once they are paid to a conventional outside insurer, they are gone forever.

A captive insurance company efficiently insures risk in various ways, such as through customized insurance policies, favorable “wholesale” rates from reinsurers, and pooled risk. Captive companies are well suited for insuring risk that would otherwise be uninsurable. Most businesses have conventional “retail” insurance policies for obvious risks, but remain exposed and subject to damages and loss from numerous other risks (i.e., they “self insure” those risks). A captive company can write customized policies for a business’s peculiar insurance needs and negotiate directly with reinsurers. A CIC is particularly well-suited to issue business casualty policies, that is, policies that cover business losses claimed by a business and not involving third-party claimants. For example, a business might insure itself against losses incurred through business interruptions arising from weather, labor problems or computer failure.

As noted above, an 831(b) CIC is exempt from taxes on up to $1.2 million of premium income annually. As a practical matter, a CIC makes economic sense when its annual receipt of premiums is about $300,000 or more. Also, a business’s total payments of insurance premiums should not exceed 10 percent of its annual revenues. A group of businesses or professionals having similar or homogeneous risks can form a multiple-parent captive (or group captive) insurance company and/or join a risk retention group (RRG) to pool resources and risks.

A captive insurance company is a separate entity with its own identity, management, finances and capitalization requirements. It is organized as an insurance company, having procedures and personnel to administer insurance policies and claims. An initial feasibility study of a business, its finances and its risks determines if a CIC is appropriate for a particular economic family. An actuarial study identifies appropriate insurance policies, corresponding premium amounts and capitalization requirements. After selection of a suitable jurisdiction, application for an insurance license may proceed. Fortunately, competent service providers have developed “turnkey” solutions for conducting the initial evaluation, licensing, and ongoing management of captive insurance companies. The annual cost for such turnkey services is typically about $50,000 to $150,000, which is high but readily offset by reduced taxes and enhanced investment growth.

A captive insurance company may be organized under the laws of one of several offshore jurisdictions or in a domestic jurisdiction (i.e., in one of 39 US states). Some captives, such as a risk retention group (RRG), must be licensed domestically. Generally, offshore jurisdictions are more accommodating than domestic insurance regulators. As a practical matter, most offshore CICs owned by a US taxpayer elect to be treated under IRC § 953(d) as a domestic company for federal taxation. An offshore CIC, however, avoids state income taxes. The costs of licensing and managing an offshore CIC are comparable to or less than doing so domestically. More importantly, an offshore company offers better asset protection opportunities than a domestic company. For example, an offshore irrevocable trust owning an offshore captive insurance company provides asset protection against creditors of the business, grantor and other beneficiaries while allowing the grantor to enjoy benefits of the trust.

For US business owners paying substantial insurance premiums every year, a captive insurance company efficiently reduces taxes and builds wealth and can be easily integrated into asset protection and estate planning structures. Up to $1.2 million of taxable income can be shifted as deductible insurance premiums from an operating business to a low-tax CIC.

Warning & Disclaimer: This is not legal or tax advice.

Internal Revenue Service Circular 230 Disclosure: As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Copyright 2011 – Thomas Swenson