Alternative Risk Planning for Entrepreneurs

Rather than covering all property & casualty risks through a conventional P&C insurer, like Liberty Mutual, alternative risk planning identifies those insurable risks which are appropriate for different treatment.

Strategy:Alternative Risk Planning for closely held businesses using Captive Insurance (essentially a private-label property & casualty insurance company)

Service Provider:Capstone Associated Services, Ltd.
Capstone has formed over CAPTIVE_FORMATIONS captives affiliated with privately-held operating businesses and has been in business since 1998.


Rather than covering all property & casualty risks through a conventional P&C insurer, like Liberty Mutual, alternative risk planning identifies those insurable risks which are appropriate for different treatment. There are often a myriad of risks which are not economically feasible to insure in the conventional markets (e.g., losses attributable to breaches of non-competition agreements, gap coverages under the typical Commercial General Liability policy, etc.)

A captive insurance company is formed to insure those property-casualty risks. The captive is owned by an affiliate of the ownership group of the business. Sometimes this is the junior generation and sometimes the senior generation. The captive can be either on-shore or off-shore, but always is taxed as a domestic U.S. corporation and always files a U.S. return.

Always the assets are located in the U.S. Contributions to the captive are currently deductible as an ordinary and necessary business expense by the operating business. From the standpoint of the captive insurer, under U.S. tax law the captive insurer is either wholly (IRC Section 501)c)(15)) or partially (Section 831(b)) tax exempt, under laws tracing back to pre-19201. The last Congressional change in this area was 2004.

Captive insurance planning is an alternative risk management and risk financing technique that can be used to accomplish several purposes including insuring the hidden property-casualty risks of its insureds and providing a more comprehensive insurance program. It is generally intended to provide broader coverage than commercial insurance and supplement commercial insurance by insuring the many coverage gaps found in commercial or conventional policies.

Four critical factors traditionally prompt a company to seek alternatives to conventional insurance:

  • Availability problems - The lack of consistently available coverages from year to year is a constant concern of insureds. Product liability coverages are a case in point.
  • Pricing inequity - Some companies believe that insurance rates are higher than what is appropriate based on their incurred and projected losses.
  • Lack of flexibility - An insured's need for coverage doesn't always dovetail with conventional coverages. Terms and conditions of conventional insurance coverages and the lack of flexibility in conventional insurance policy language to address particular risk concerns sometimes leads to alternative risk planning.
  • Lack of certainty of coverages being honored – Many insureds have experienced the practical difficulty in collecting from a property & casualty insurer when a claim arises under policies such as Business Interruption, Commercial General Liability, Loss of Services, etc. This also drives business owners to utilize captives.

Widespread Use:

Captives are widely used in the business community, generally by larger companies. There are more than 5,000 captive worldwide. Capstone specializes in captives for privately-held, middle market companies. Often their owners are looking for creative solutions to business problems.

Potential Issues:

While the following is a discussion of the issues, Capstone is well familiar with the issues following experience developed over the last CAP_YEARS_NUMBER years and CAPTIVE_FORMATIONS+ captives formed. Additionally, Capstone has obtained 40+/- rulings from the IRS on the tax exempt nature of small captives and several years ago successfully completed 10+ audits seen in the last ten years spread across 500+ year end tax returns filed.

As we see the issues, in order to constitute an insurance arrangement, both risk shifting and risk distribution must exist. In Revenue Ruling 2005-40 the IRS indicated that the risk distribution component is not satisfied if a single employer or a group of affiliated disregarded entities establishes a captive insurance company.

Thus, a captive insurance company can only be done where the captive insurers multiple business entities that are not disregarded entities. Capstone operates several “third party” insurance arrangements that satisfy these revenue rulings. While most of Capstone’s clients have multiple business entities, Capstone has obtained tax exempt rulings from the IRS where the captive owner had only one other business entity beside the captive. See examples below.


Capstone makes its money from fees charged to the business owner for its turnkey program to establish and maintain the captive insurance company. Capstone forms and operates the captive on a multi-year, turnkey basis. It brings together a diverse team of professionals under its umbrella.

1 ”Small” captives (less than $600,000 in gross receipts, which includes both underwriting and investment income) are wholly tax exempt on underwriting and investment activities. Intermediate captives (up to CURRENT_PREMIUM_CAP million in policy premium revenue) are not taxed on their underwriting income. Capstone reports that its administered captives have under $400 million in assets on hand.