► Captive Insurance Companies
Created by a business owner or a company to incorporate its own insurance subsidiary, i.e., the insurer is captive to the policyholder.
- Pure captive: the captive insurance company insures own its parent and affiliates.
- Homogeneous captive: the captive insurance company insures one type of industry.
- Heterogeneous captive: a captive insurance company insures a group of diverse companies.
Captives often have co-directors: one experienced in captive management, formation, licensing, and ongoing services, and one experienced in general business financial matters.
- With a captive or risk retention group, you stabilize coverage for your specific exposures while participating in the underwriting profit and investment income.
- You control the processing of claims, have flexibility with policy provisions, and gain special cash flow advantages.
- Gives you an excellent tool to help manage risk and control costs.
The formation (incorporation) and licensing process comprises two elements: the structuring of the captive and application for admission to the state of domicile.
- The process should start with risk and insurance.
- Assess the viability of a captive or risk retention group.
- Prepare, submit, and monitor application to domiciliary regulators.
- Identify service providers, such as auditors, actuaries, attorneys, and bankers, and act as a liaison with them and with regulatory authorities.
- Consider domicile alternatives, captive structure, retention levels, and capitalization.
- Estimate initial contribution, reinsurance and excess insurance placements.
- Access both brokered and direct reinsurance markets.
- Establish investment management guidelines and protocol to monitor performance.
- Design and implement client-oriented accounting and insurance recordkeeping, control, and reporting procedures.
- A captive could be a good vehicle to comply with Obamacare (i.e., more than 50 employees).
- The captive should be built on a solid foundation, with legitimate insurance coverages.
- Regulatory compliance.
- Financial reports, including annual and quarterly statements, periodic and statutory financial statements and underwriting, statistical, and management reports, tax returns and other required filings.
- Home office and a local director, if required.
- Policy documentation.
- Directors’ and Shareholders’ meetings, and meeting materials.
What to consider:
- If you exceed annual captive contribution of $1.2 million, you create taxable income, under IRC 831(b).
- There must be a valid reason and purpose: a policy that has been issued that requires a premium payment into the captive, so the program satisfies the letter of the law regarding real insurance.
- There are investment restrictions, just like there are for insurance companies – what would be generally accepted for insurance companies.
- There should be a real insurance business risk transfer and risk distribution happening for the company, and then the captive would only pay taxes on its investment income.
- The captive business should be conducted like an insurance company; assuming real risk in exchange for a reasonable premium and for a legitimate purpose.
- For deductions under IRC 831(b) to withstand IRS scrutiny the tax deferral advantage should not be the primary driver: the captive should be built as an insurance company, not as a scheme to reduce taxes.
- After year one, and there is a conservative track record, the manager of the captive could consider being a bit more aggressive.
- All investments are subject to approval of the Department of Insurance.
- A captive could be domestic – certain states are set up for it (including Arizona). In Arizona’s regulatory framework, a separate division solely dedicated to Captive Insurers has been created and is supported by a staff of professionals.
- Organizers of captives recommend participating in a “pool” creating risks other than your own. This creates a dangerous upper level: should just a couple of the coverages in one of the programs be challenged it could literally take down every one of the captives that share that questionable coverage’s risk.
- Pools rarely, if ever, accept medical risks.
- There are setup and annual costs.