Update: New legislation passed in 2015, effective in 2017, affects ownership rules for captive insurance companies. See our official announcement.
The idea of self-insurance isn’t a new one. People from all walks of life have been stocking away funds for the inevitable, albeit unpredictable, rainy day. In business, these provisions have become an integral piece of the risk management game puzzle as operational and financial risks are not always predictable. Financial products have made their way into our corporate consciousness as an absolute need. Not only do 401k and IRA savings accounts, bonds, trusts, and insurance improve the health of a business, but they’ve long been considered a rock-solid foundation for financial security for individuals and future generations. They undoubtedly improve financial planning inefficiencies.
But they do have their drawbacks.
For example, including one or more large deductibles in your insurance program is an excellent way to reduce insurance costs, take greater control of your risk management plan, and ultimately decrease losses that are disruptive to your business and to society. Unfortunately, the tax code does not recognize reserves for self-insured exposures as a tax deduction. Rather, the deduction can only be taken when the actual payment is made. At today’s high tax rates, the many advantages of self-insurance are mitigated by the loss of a legitimate tax deduction. This problem can be resolved through the use of captive insurance planning.
Forming a captive insurance company takes the ideas of self-insurance and flips it on its head--inherent operational and business risks can be covered by tailor-made coverages with tax-deductible dollars. Reserves and surplus may be invested by the captive and retained for losses or eventually to fund shareholder distributions. If you have a need to replace business-related equipment, the captive may be able to make a secured loan to its affiliated companies.
Funds inside the captive insurance program accumulate over time and can be a financial asset to the practice or business, subject to claims history. Depending on claims events, these funds could continue to grow.
One major advantage to forming a captive insurance company is that virtually anyone can own it. A family member—a son, a daughter, a cousin, an uncle—can be the captive owner and handle the regulatory obligations thereof. A well-organized captive can be beneficial to future generations where a trust for the benefit of the client's spouse or descendants owns the captive.
This is possible because the ownership of the captive insurance company does not have to match exactly the ownership of the operating company. In fact, a captive can be held by a completely different ownership structure like a trust or partnership.
It is clear that forming a captive insurance company is a great way to insure operating businesses with significant risks, as it provides comprehensive coverage as well as secondary benefits, such as ownership benefits to other parties, including children, key employees or charitable organizations. Protecting the business you have built can be an interesting and rewarding challenge. It is a tradition that can be adopted by the people you trust the most.