IS CAPTIVE INSURANCE 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.
A captive insurance company is created to insure the risks of a specific business. Even though a business can transfer risk to an insurance carrier, exclusions in conventional insurance contracts often force business owners to absorb the hefty costs of a claim. Fortunately, owning a captive can minimize or even eliminate these exclusions.
To create a captive, an individual typically hires an attorney or an experienced captive management firm who establishes 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 made to its owners), receive premium dollars, invest those premiums to pay claims and, when needed, approach the reinsurance market to purchase reinsurance to cover losses. These coverages allow the owner to simultaneously manage its risk and potentially minimize its current insurance cost by having the captive assume that risk.
If its insurance claims are low, the captive could accumulate significant money, thus creating a profit center for its owner. The structure of the captive will determine the manner in which the income of the captive is taxed during both the accumulation and the payout phases. Of course, a properly structured captive can minimize the tax impact of gains realized by the captive.