How Captive Insurance Really Benefits the Business Owner

When an insurance company is owned by its parent company to protect its own assets and risks it is called captive insurance. In such cases, the policy holder is a parent company that usually owns many subsidiaries or related companies. The formation of the captive insurance company is done to protect itself or its subsidiaries against losses in case of any business related mishap. In this tumultuous and litigious climate that most businesses operate in, having a captive insurance company in place makes immense sense. Captive insurance companies are increasingly becoming an essential part of risk management.

Where captive insurance really benefits the business owner

Companies, whether they are big or small, are finding it increasingly difficult to afford traditional insurance. The cost of insurance premiums continue to soar and it does not appear that this trend will reverse itself anytime soon. Additionally, qualification standards for traditional insurance are increasingly stringent, given the bad experiences the insurance companies have had in the recent financial crisis. When companies do manage to qualify, the premiums are steep and unaffordable. As a result, companies for bear certain kinds of insurance and thereby expose themselves to potentially encounter huge losses. In order to avert such situations, captive insurance becomes a necessary and powerful solution.

There are many benefits to captive insurance. First, as compared to traditional insurance companies’ premium structures, the cost of insurance is much lower. One of the major reasons for this is that a company is not paying to cover any overhead costs or profits of the insurance company. The primary intention of what is captive insurance company, does not have to be profit generation, but to provide better coverage at lower premium costs. Another big benefit to forming a captive is that the claims process is greatly simplified. In a normal scenario, with a traditional insurance company, the parent company is subjected to a biased claims process. However, when a captive is present, the Parent is in complete control of the claims review process, thus it dictates whatever decision it feels appropriate to best serve its interests.

Wealth accumulation through captives

Because the parent company owns the captive, it can tailor make its coverage limits, policy requirements and premium pricing. So the parent, typically, pays lower premiums which will drive cash flow and profits. And, the parent retains the premium dollars it pays to the captive, which it then invests in a variety of investment vehicles. Overtime, with prudent investing strategies and low claims made, the company can become a sizable and powerful asset to the parent company.

Any company that is profitable, has identifiable business risk, and pays high existing insurance premiums is usually a good candidate to form a company.

Formation is a straight forward process of

1) generating a feasibility study

2) writing policies, pricing premiums

3) physical formation of the entity

4) on going management of the company, typically using a qualified 3rd party management company.

Tax Compliance in the EU – A Thorny Issue for Captive Insurers

Insurance Premium Tax (IPT) is an often overlooked source of risk for captives and their parents.

Now that the tax benefits of self-insuring through offshore parties are generally eroded, the captive industry is largely dependent for its success on a high level of risk transfer and risk management expertise. The requirements of IPT payment in the EU complicate these processes and can be an unwelcome and time-consuming distraction for captives not adequately informed or prepared.

Complying with European Union IPT tax laws is an issue for all captives – and traditional insurers – insuring risks within the EU, regardless of where they are domiciled. This is because EU law determines liability for IPT according to Location of Risk.

The EU’s Second Non-Life Directive defines the Location of Risk as the specific country where the insured risk is situated. This ensures consistency in risk assessment and avoids IPT being double taxed – each IPT payment can only be collected in the country where the risk is located. This directive is one area of IPT on which the EU has provided some uniformity.

This concept can be illustrated by the example of, say, a captive with a Dutch corporate parent insuring a factory in Spain: the captive must charge and collect IPT on the Spanish share of the premium and appoint a Spanish tax representative to act on its behalf with the authorities, paying and reporting IPT according to Spanish legislation.

Captives based within the EU (such as in Gibraltar or Malta), in Europe but outside the EU (Jersey), or in any other location (including Bermuda and the Cayman Islands) are all subject to these principles when insuring risk within EU countries.

However, there is no harmonized system of IPT settlement and collection within the EU itself – individual countries are free to decide how and whether to tax insurance premiums. Currently 21 of the 27 EU member states operate IPT regimes, but these vary widely in terms of business classes liable for such taxes and in terms of collection processes.

The complexity of EU IPT is therefore evident, and is deepened further by the 23 official languages and 13 different currencies used in the EU. A multinational corporation operating across several EU territories, perhaps moving its employees and goods from one location to another in the course of its business, can find itself subject to a plethora of national tax codes, practices and cultures.

Captives working within such organizations are often managed by independent insurers whose skills and know-how are focussed on risk, not tax. The potential for non-compliance with IPT regulation in such cases is considerable, and the reputational and financial consequences captives and their parents can suffer are serious. In 2001, the European Court of Justice set a precedent in the Kvaerner case, giving national tax authorities the right to pursue buyers of insurance for premiums unpaid by their insurers. The pressure on captives to come up with complete and reliable solutions for IPT compliance is clearly significant.

The desire for financial and operational efficiency that drives most captives means that many now choose to outsource the management of IPT payments entirely. In addition to keeping captives’ structures lean, this can bring greater transparency to the compliance process than has often been the case, and also reduces a web of multiple relationships to a single point of contact – a ‘fire and forget’ approach to IPT compliance that is rapidly gaining ground. Other captives may still choose to manage the situation directly, typically overseeing a network of local fiscal representatives in various EU states. In choosing between these options, it is important for the captive to decide the level of administrative involvement it desires and, for compliance purposes, to confirm that they will receive documented proof that taxes have been correctly calculated and paid.

IPT is a fact of life when managing risks in the EU, but should not exert undue influence on the commercial decisions taken. By finding the right solution for its needs, a captive can focus on its core task, confident that its tax compliance is assured.

Captive Insurance Is A Smart Money Saving Business Option

Captive insurance is provided by a company that has been formed by a larger parent company specifically to care for risk management needs. This sort of insurance is not given to the public, but instead serves as an alternative risk management solution for companies who do not want to use traditional insurance. Large and small businesses alike stand to benefit financially and otherwise by using captive manager to handle their risk management in house.

A few companies have found that the costs of purchasing an insurance policy actually outweigh their potential losses. Forming captive manager companies permits a business to notably reduce its spending on insurance policies. Insurance rates are calculated using the financial risks of a company, but if one business has much less risk than another in its industry, it may wind up paying more than is necessary simply because of insurance company policies. They also have to add to premiums and rates in order to make up for overhead costs and make a profit. This pricing inefficiency does not occur with the agencies. Captive agencies are able to make operating policies that are not full of the legal red tape that make most insurance policies so hard to deal with.

Captive insurance arrangements must come under the requirements of contract, insurance, and tax laws. For example, if an established business forms a sister company for use as a captive manager company, the two must be completely separate in legal and tax terms. The captive company must be handled as an insurance company in order for the insured to claim deductibles for their payments on their taxes.

There are several different types of captive insurance agencies. When a single parent captive agency is formed, it sells its policies only to its parent company. An association captive company is created by several different companies in an industry; the insurance they provide benefits their members. Normal insurance companies can also protect themselves from the risk of many clients simultaneously demanding huge compensation payments. To care for this financial risk, they form their own agency captives. If an insurance company has enormous losses, they can share those losses with their subsidiary captive agency.

Captive insurance can allow a company to form a strong risk management plan without requiring them to pay exorbitant rates to insurance companies. These subsidiary companies make possible insurance for employee benefits, product liability, physical property damage, professional indemnity, and more.