There has been a lot of "buzz" in the marketplace about captive insurance lately. A lot of confusion accompanies the talk since understanding what captive insurance companies are, how they work and who they work for can be a little complicated.
Understanding Captive Insurance Companies
It is not something new, nor is it particularly aggressive. In fact, estimates are that 400 of the S&P 500 companies operate their own captive insurance companies. What is most important to know is that in the right circumstances for the right client, a captive insurance company can be a powerful alternative risk planning tool.
Here's a brief overview.
Every successful business pays for various types of insurance, normally to a commercial insurance carrier. These payments may be for property coverage, employee disability, worker's comp, business interruption and a myriad of other risks. Often these premiums represent a large portion of the business overhead and the premiums can vary unpredictably and greatly from one year to the next. The good news is that most insurance premiums are tax deductible to the business as an ordinary and necessary business expense.
Benefits of Captive Insurance Companies
You own the Captive
While insurance is a necessary cost of doing business, it can also be a source of frustration for the business owner. However, what if the business owner could establish his own insurance company that would insure some of the risks of his particular enterprise? And what if that company paid out less in claims and other costs than it took in premiums (like most insurance companies)? Then the profit would accrue to the new insurance company and its owner. This essentially is what Captive Insurance is. Obviously, it's a little more complicated both in structure and by regulation but the concept is like all other insurance.
Captives Meet Your Business Needs
What makes captive insurance intriguing for the appropriate client? Several reasons. First, insurance is a necessity for every business. If it's possible to take on some of the lower risk items and retain some of the profit that would otherwise go to a commercial carrier, then there is a compelling economic incentive and another profit center.
Captives Are Separate Businesses
Next, the captive insurance company is a new, separate business entity. As an estate planning and wealth accumulation tool, a new captive may be unsurpassed. To establish a new captive insurance company, a new business entity must be formed. If wealth transfer to heirs is a desired goal, then when the company is being formed, ownership interests can be given to children or trusts for children or other heirs so that wealth from profits can inure to their benefit.
Captive Premiums Are Deductible
The premium payments, which are deductible to the business, are not subject to gift tax limitations and the captive can be outside of the business owner's estate from the very beginning of its existence.
End of Year Tax Savings
Furthermore, many businesses can take advantage of a special provision for "small" captives, those with annual deposits up to CURRENT_PREMIUM_CAP million. In this instance, even though the premiums are deductible by the paying corporation or business entity, the captive does not pay income tax on the premium deposits it receives.
Captives Build Wealth for Business Owners
This allows for a great wealth building tool for the business owner. This means that along with all of the other estate planning tools a business owner can use, it is possible to transfer as much as CURRENT_PREMIUM_CAP million a year in addition. While some expenses occur annually and some claims will necessarily be paid, the potential wealth transfer can still be quite powerful.
Captive Insurance is not for everyone
With all of these potential benefits it would seem that every business should utilize some form of this structure. Unfortunately, captives aren't for everyone. Normally, a business should have $15 million in sales and have enough net profit to comfortably deposit $500,000 per year into the captive company. Set up and operating costs currently limit the marketplace to somewhat larger concerns.
There are many additional considerations regarding the captive structure that are beyond the scope of this article. Where will the captive be located, onshore or offshore? What risks will be insured and at what level? How much will capitalization be in order to provide economic substance? Who will administer the captive and pay the claims?
Obviously many questions need to be answered before undertaking such a major commitment. However, the resources have been developed to make this process less cumbersome and threatening than it appears. Finding the captive management expertise to help you through this new territory can provide huge benefits for many business owners and is certainly worth the effort.