Is Captive Insurance a Legitimate Tax Shelter?

The protection from tax assessment is a sought-after benefit for the parent company. Each business owner has their own definition of a substandard return on investment. Gauging a captive’s value primarily on its ability to earn a minimum ROI is a faulty analysis. However, if the business owner mandates that the captive’s capital must meet or exceed a specific hurdle rate and/or provide positive returns within a relatively short time frame, captive ownership may not be a good fit. At a minimum, business owners should have a five-year time horizon to see distributions of underwriting profit. For many organizations, the benefits of greater control, lower costs, and increased stability/transparency outweigh the risks.

Before deciding whether an insurance captive is the ideal solution for a company’s risk management needs, it is important to carefully weigh its advantages and disadvantages. Captive insurance companies are often formed to supplement commercial insurance, allowing the parent company to keep the money it would otherwise spend on additional insurance premiums. While the start-up costs are more expensive at the onset, you have the potential to lower your insurance premiums once the plan is in place.

To the extent investment income can accumulate in a tax-free domicile,
there will be additional funds available to pay losses and a corresponding reduction for further
funding of the captive. The primary advantage of captive insurance is that it keeps costs centralized. It provides an option for corporations, groups, and individuals to manage risks by underwriting their own insurance. That reduces the number of premiums that must be sent out to third-party insurers, providing more overall control for the insurance experience. Running a successful business requires business owners and managers to evaluate all expenses and sources of revenue.

  1. That means the loss reserves of the captive are allowed to accumulate untaxed until they are taken as earnings.
  2. This ensures you’re offering the right type of care for your team.
  3. Cell captives typically have lower start-up capital and ongoing frictional costs than single parent captives.
  4. Additional time, money, personnel, and
    management commitment are required for these services.

As with all business decisions, a cost-benefit analysis is a must before deciding whether the captive option is a good fit for a particular business. While a successfully established and maintained captive program does yield tangible rewards, there are also some potential financial disadvantages to take into account. The ability of a captive to generate investment income from unearned premiums received is often
a critical advantage in forming a captive. This is especially so where premiums are paid in
advance and losses are paid out over a lengthy period of time (which, in turn, depends on the
kinds of risks insured).

Cons of a Captive Insurance Plan

Captive insurance refers to an arrangement in which an entity chooses to provide insurance for its members by using its own assets, rather than purchasing it on the open market. Captive insurance often is used in at attempt to reduce costs or gain more control over benefits administration. Despite these advantages, a captive arrangement has potential disadvantages as well. In a more recent example, the state of Tennessee launched its own captive insurance company in 2022 to cover state-owned buildings and contents, including Tennessee’s public college campuses, as well as general liability. The captive insures property valued at $31.4 billion as of July 2022. A captive insurance structure is considered a “single parent” structure.

Membership Pays

Captive agents are also usually paid a salary and commission and receive benefits. Independent contractors are usually just paid commission and have to provide benefits for themselves. It’s important to know that there’s more than one kind of
captive. Let’s take just a minute to define the main types of captive insurance
programs out there. In order to gain that independence, however, you must assume
the possibility of greater financial risk. When you make the switch to captive
insurance, you’re gambling with your own money, and no longer have your insurance
provider to fall back on because you are now the provider.

Captive Operation and Management

A group captive insurance policy may be a good alternative to cover a business’ common risks. Commercial insurance companies establish premiums for businesses based on the loss experience of similar types of businesses in the industry. Even if a company maintains an excellent loss experience ratio, their rates could increase based upon excessive losses from a similar business within the risk pool. Traditional insurance companies play a vital role in helping businesses manage and mitigate risks, yet insurance costs can get out of control. Unless a company is extremely large, it is not practical to self-insure for all risks. Being an independent agent requires having to start one’s own business, which entails all of the aspects of setting up shop, as well as having to find insurance companies to work with.

The following summarizes some of the advantages and disadvantages of captive
ownership to consider when deciding whether to form a captive insurance company or not. Captive insurance provides claims management and enhanced loss prevention activities. No form of risk financing would be able to succeed if these activities were absent. Every type of active that establishes, and then maintains, claims management and high levels of loss prevention through its standards and protocols will always pay dividends to policy holders over time. The amount of time it takes to achieve those dividends varies based on the circumstances experienced by the policy holders. As with any other insurance company, group captives have their share of pros and cons.

We will look at the advantages and disadvantages to help you determine if a group captive insurance company is right for you. Also commonly called an 831 (b) captive or small captive, a micro captive insurance company makes an IRS 831(b) election to be taxed on investment income only (not on premiums collected). Collected premium dollars must be below the threshold for the given tax year for a small captive to qualify.

Companies that use them generally rely on conventional commercial insurers to protect against certain risks. A captive insurance company (or captive) is formed, owned, and controlled by the parent company that it insures. The National Association of Insurance Commissioners (NAIC) estimates that about 90% of Fortune 500 companies today have captive subsidiaries.

He holds a Bachelor of Science in marketing from York College of Pennsylvania. If you want to learn more about how a captive program could help you start saving, reach out today. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more.

An organization could employ captives as a way to protect themselves against product liabilities and the legal claims that arise from it, for example. If you’re in an accident with your vehicle, you still have control over your budget because you know what your costs will be, based on the type of accident you have and who may be at fault. Captives make it possible disadvantages of captive insurance for organizations, groups, and individuals to have a more active role in how primary losses are paid. Control grows based on assets instead of starting over each year, as it would if there was a large deductible in place. Some insurance carriers still impose quotas for selling products, even if they are subpar when compared to competing products on the market.

Captive insurance is also sometimes promoted as a tax shelter, but using it that way has its hazards. 2020 taught us that threats to growing a business continue to evolve, and it’s hard to be ready for whatever might come next. Insurance companies provide a level of risk mitigation, but more companies are starting to look at doing this internally. A captive insurance company is an affiliated company with common ownership established to provide insurance, or risk mitigation services, to its operating company. In some cases, a captive insurance company can be more equipped to help its operating company face emerging threats than a third-party insurance provider. A 2021 report on the state of the captive insurance industry found that the formation of captive insurance companies almost doubled in 2020.

How is Captive Insurance Different from Commercial Insurance?

If a captive is appropriate, the team customizes a structure, implements, operates and services the captive-related insurance program throughout its lifecycle. Executives and their stakeholders benefit by strengthening the organization’s financial performance while protecting its assets. Captive insurance can meet risk-management needs for a small or large company while providing financial rewards for its owners. Typically, initial premiums can run into the hundreds of thousands of dollars or even millions. And there are considerable start-up costs—often more than a quarter of a million dollars, to create a captive insurance company and cover fees to actuaries, attorneys, and others. A captive insurance company is one that is owned by the business or businesses it insures.

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