Captive Insurance Company Benefits

| August 19, 2017
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The Benefits of owning a Captive Insurance Company

A little background on what a captive is an insurance company is. Captive insurance companies are wholly-owned by one or more non-insurance companies to insure the risks of its owner (or owners). Captives are really a form of self-insurance whereby the insurer is owned wholly by the insured. They are typically established to meet the risk-management needs of the owners or members. Captives are formed to cover a wide range of risks; practically every risk underwritten by a commercial insurer can be provided by a captive.

To begin, let us be clear that captives are all about money. You want one to make money. It will cost money to have one. You will pay your own losses, come what may.

Captives are another method by which risk of loss is financed. They are not inherently mysterious, or illegal, or a silver bullet for all situations and have been around for over 100 years. The fact that the insured, or an entity closely related to the insured, is the owner/operator is a separate and distinct fact, which may or may not intrude on the captive transaction.

Captives versus Traditional Insurance 

When you apply for insurance you do so by giving underwriting information to a party who enters into a contract with you to provide repayment of losses under certain circumstances if premiums are paid and the contract is in force. There are many variations on this theme, but all of that is known as "traditional insurance." To go outside this structure is alternative risk finance, which can take many forms, one of which is a captive insurance company.

With a captive, instead of "just writing a check," you will see all the components of the premium and play a part in its pricing and delivery. This is called "unbundling."

Another critical point is that alternative risk finance is not in opposition, or the enemy of, the traditional insurance company. In fact, most traditional companies work daily with captives and other forms of risk finance. As a part of the process, someone of financial strength must agree to reimburse claims. For large losses, a large insurer is required. That is probably not the captive.

For small losses, the traditional insurer often prefers that the insured handle those. This provides an opportunity for the insurer to shift costs to the insured through the device of a captive. These costs can also be shifted through deductibles, retentions, and coinsurance, but a captive can create the illusion of control for the insured while eliminating nuisance costs for the insurer. This illusion can be a highly successful marketing tool for a traditional insurer.

A Captive can also be used to cover gaps in coverage for business enterprise risk or interruption. Here are just some of the actual net loss Insurance policy scheduled events that can be covered with a captive. (contact our office for a full list)

Administrative Actions  

Breach/Release of Data

Business Interruption 

Computer System Failure

Crime Misappropriation of Funds 

HIPAA Violations

Intellectual Property 

Suppliers/ Supply Chain Interruption

FAA Fines

Physicians Regulatory Defense Costs 

(contact our office for a full list of 63 events)

Captive Tax Advantages

There are many, many other considerations and structures to a captive. It can reinsure traditional lines such as workers compensation, general liability, auto liability, professional liability, and credit risk. This is due to the relative ease and certainty of projecting losses and revenues with coverages in which claim payments occur years after the incident of loss, known as long-tail losses. More and more captives are entering property fields or short-tail losses. The traditional view of restricting captives to long-tail business has encountered the reality of escalating prices and lack of availability.

A captive can also be used to provide coverage and limits not available in the market, such as credit risk and terrorism. The captive can provide a tax-sheltered approach to large retentions. If no certificate is required, it can accept direct placements.

Captives are highly regulated and are required to operate as bona fide insurance companies. Therefore, acceptable uninsured risks must be present before a captive insurance company can be formed.

Once the captive is operational, with coverages designed to fit the insurance needs of the business, the captive owner or “insured” may be eligible for captive insurance tax advantages (namely with captives formed under IRC 831(b).

For example, $1,000,000 in earned profits are subject to a tax margin of at least 45%, and in some states, over 50%. This means, by not using a captive, at least 45% (or $450,000) is taxable, leaving you with a retainer of $550,000.

With a captive, you can retain the full $1,000,000. The monies are kept in the captive to cover unexpected losses. And if those losses don’t come to fruition, you can retain these funds as investment income.

Captive insurance tax benefits under IRC 831(b) have been a proven strategy for improving cash flow for many mid-market businesses. It has allowed business owners in the middle market to play on a more level playing field with large insurers.

Ultimately, the financial benefits to captive and alternative risk planning promote growth, sustainability, and resilience.

With considerable effort, there are occasional personal tax advantages that can be obtained with a captive, but these require a sophisticated, knowledgeable consultant, and there are the usual caveats about taxing bodies.

Some captives have performed so well for their owners that they have re-domesticated to the United States, filed for licensing as an admitted insurer, and offered primary coverage, replacing their risk-sharing partner.

Captive Insurance Company with Cash Value Equity Indexed Universal Life

Though Captive Insurance Companies are not benefiting plans, they can prove to be an excellent retirement planning strategy that also offers asset protection. The asset protection comes in the form of business insurance. The business is really insuring itself against any losses. As well, providing insurance claims are minimal the business owner can withdraw the cash from the Captive Insurance Company with the long terms tax rate for any capital gains. With proper retirement planning, the business owner can withdraw the cash without paying any taxes.

Moreover, in a Captive Insurance Company set up, it is wise to use a high cash value Indexed Universal Life (IUL) policy as a strategy to grow the reserves in the CIC while having protection from the volatility of the stock market.

If your approach is well thought, properly executed and diligently managed, a captive can be an ongoing source of profit for years to come.

It is important to work with a consultant familiar with the Captive structure and who works with an advisory firm that provides captive insurance planning and management services. Chamberlin Financial works with one of the top risk management firms in the country that specializes in Captive structures.  

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