What is a Captive Insurance Company?

  • A Captive insurance company is a company created to insure the risks of a specific business(s). Although risk management policies exist in the market, exclusions forces business owners to absorb the hefty costs of claim coverage.
  • Owning a Captive can minimize these exclusions, since they are a variety of risks that are generally not offered in the conventional insurance market.

 

What is a 831B?

  • 831(b) effectively allows a small insurance company to receive up to $2.2 million per year in premiums, without paying any income taxes on those premiums.
  • The 831(b) election does not affect — at all — the deductibility of the premiums paid by the operating business to the Captive. Premiums are otherwise deductible, they may be deducted by the operating business just like any premium payments to a Captive.
  • This has the effect of creating an up to $2.2 million deduction in the operating business, with the premium moneys transferred to the Captive, and with the Captive not paying any income taxes on the receipt of those premiums.

 

How does a captive work?

An individual, company or trust sets up and forms an insurance company. Once licensed, the Captive functions just as most insurance companies do. It can sell insurance coverage (but generally such sales are only to its owners), receive premium dollars and invest them to pay claims and, when needed, approach the reinsurance market to purchase reinsurance to cover losses.

If the insurance claims are low, the Captive will, over time, accumulate significant money. Depending on the structure of the Captive, the income will be taxed in various ways during the wealth accumulation phase (as well as the payout phase) to the Captive owner.

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Why a captive might be right for your business?

  • Lower Insurance Costs – This is achieved through designing proper coverage limits, elimination or reduction of broker commissions and lower administrative costs.
  • Cash Flow – Insurers rely on investment and underwriting profit to generate cash flow. Premiums are typically paid in advance while claims are paid out over a longer period of time. By utilizing a Captive, premiums and investment income are retained within the Captive. The Captive can also provide a more flexible premium payment plan thereby offering a direct cash flow advantage to the parent.
  • Access to the Reinsurance Market – A Captive can access the reinsurance market which operates on a lower cost structure that a direct insurer.
  • Flexibility – A Captive can design the coverages that apply to the specific needs of the company and structure the policy accordingly.
  • Coverage Provision – Captives can provide coverage for risks not available or that are too expensive to obtain in the traditional marketplace.
  • Tax Benefits – Insurance companies are provided a special tax treatment. They can accrue tax deductible reserves for unpaid claims, whether known or estimated. The cash reserves inside of the Captive are invested.

 

If your company pays insurance premiums to the Captive insurance company, it is generally tax deductible for your business – but the receipt of premium income is tax free to the Captive. If the claims against the insurance company are managed properly, the reserves will accumulate much quicker and there will be a more profitable company. More profits, in turn, could result in greater gain for the shareholder. At the time of retirement, you can sell your share of stock in the insurance company, receive such increased value as a long-term capital gain. Currently, long term capital gains are taxed at a maximum federal rate of 20%.

  • 953 (d) Election – An insurance company that is formed offshore may elect to be taxed as a domestic US Corporation. This election requires the offshore insurance company to pay taxes the same as a domestic US Corporation. This generally eliminates any problems that could occur by the Controlled Foreign Corporation rules and allows for full reporting and payment of any taxes due to the IRS.