United States: Should Your Business Have A Small Captive Insurance Company?

For a profitable business, a captive insurance company arrangement can be an effective and flexible business risk management tool that also provides potentially significant tax and asset protection benefits. This newsletter provides an overview of the benefits of a small casualty insurance company arrangement for a closely-held business.

TYPICAL CAPTIVE INSURANCE COMPANY ARRANGEMENT

In a typical captive insurance company arrangement, a business owner forms and capitalizes a state licensed and regulated insurance company (the "Captive") which then issues to the business insurance policies covering risks that are not insured under the business's existing commercial insurance policies (such as deductibles and uninsured risks). The Captive might be owned by a trust for the benefit of the business owner's family.

The following diagram illustrates a typical captive insurance company arrangement.

The costs to form and operate a captive insurance arrangement include:

(a) the cost to capitalize the captive (which ranges between $100,000 and $500,000 for a typical structure, but can be as low as $25,000 for certain pooled insurance arrangements),

(b) expenses associated with identifying business risks that are appropriate to insure through the Captive and with setting reasonable premium rates for the insurance, and

(c) expenses for a third-party administrator to assist with the formation and ongoing administration of the Captive (e.g., administration of insurance policies in force, accounting for premium billings and collections and investment of capital and underwriting reserves, preparation and filing of annual reports and other regulatory filings, and other administration matters).

A captive insurance arrangement can be economically viable with annual premium volume of as little as $100,000.

Premiums paid to the Captive are invested during the policy period (along with the initial capital amount) in investments authorized by the applicable regulatory scheme, which generally requires highly liquid low-risk investments. Once the policy period for a pool of premiums expires, any underwriting profits can generally be distributed as a dividend or reinvested in less restrictive investment classes.

RISK MANAGEMENT BENEFITS

A captive insurance arrangement is first and foremost a powerful risk management tool. The Captive typically writes insurance policies covering risks of the operating business that are not currently being insured under the company's existing commercial insurance policies. Examples include loss of key vendors or major contracts, expenses to repair media reputational damage, adverse financial consequences of legislative and regulatory changes, and loss of franchise license or lease. Policies covering these risks are often not available in the commercial insurance market or may prove too costly to obtain. Many of the risks that should be considered for a captive can be found in the exclusions sections of the company's existing policies, and an uncovered loss is often the impetus for a business establishing a captive.

By obtaining coverage for these risks through the Captive, the company can more effectively identify its uninsured risks, institute loss prevention and containment measures for the risks as appropriate, and set aside assets to cover future losses and smooth the cash flow effects of a loss. A Captive has many advantages over insuring the risks in the traditional insurance market, including streamlining claims review and processing, insulating the company from wild swings in premium rates that can occur in the commercial insurance markets, avoiding or minimizing profit loads, broker commissions, and administrative costs associated with traditional insurance, and capturing for the company savings associated with investment of policy reserves and better than average claims experience. Analysis of these advantages can sometimes cause a company to reconsider whether some risks being insured through the traditional insurance market should instead be insured through a captive arrangement.

TAX BENEFITS

In addition to providing impressive risk management benefits, a small captive insurance company enjoys a significant income tax benefit. And, in the context of a closely held business, a captive insurance arrangement can also provide significant gift and estate tax benefits.

Income Tax Benefits

Assuming the Captive receives less than $1.2 million of net written premiums for the tax year, it is subject to tax only on its taxable investment income; its underwriting income is exempt from tax. This means that while the business obtains a deduction against ordinary income for the premiums paid to the Captive, the Captive is not subject to tax on the premium income. Business profits are effectively converted into nontaxable income. When the Captive's underwriting income is distributed to the family trust, the trust (or the grantor, if the trust is a grantor trust) is taxed on the income at qualified dividend rates.

If a business generates significantly more than $1.2 million in profits and premiums annually, it may be possible to use more than one small captive insurance company arrangement to maximize the income tax benefits of the arrangement.

Estate Tax Benefits

In addition to the income tax benefits described above, a small captive insurance company arrangement can also provide significant gift and estate tax benefits. Underwriting profits of the Captive, which would, in the absence of the captive arrangement, accrue to the business owner and be included in his or her taxable estate at death, now accrue to the family trust without incidence of gift or estate taxes and without using any of the business owner's annual or lifetime exclusion amounts. Depending on the profitability of the underlying insurance, the captive arrangement can move substantial assets from the business owner to his or her family free from gift and estate taxes and at deferred and reduced income tax rates. Structured properly, the family trust also may be able to take advantage of generation-skipping.

Note also that by having the family trust taxed as an intentionally defective grantor trust for income tax purposes, the business owner can effectively move additional assets to the trust by paying the income taxes due on income of the trust (i.e., dividends received from the Captive).

ASSET PROTECTION PLANNING

In a properly structured captive insurance arrangement, the premium dollars moved to the Captive, and the earnings on those premium dollars, are removed from the reach of creditors of the business and the owners, except to the extent the premiums and earnings are used to cover losses insured by the Captive. For the owners of a business operating in a high risk industry (like health care, chemicals, transportation, etc.), or for any business owner concerned about potential future creditor claims, the asset protection planning afforded by a captive can be a significant benefit.

CONCLUSION

For a profitable privately held business, a captive insurance arrangement can be a powerful risk management tool that provides significant income tax, estate and gift planning, and asset protection benefits. If you are an owner of, or advisor to, such a business, Strasburger lawyers can assist you in reviewing and implementing a captive insurance arrangement for the business if one makes sense.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions