What Is A Captive?
A Captive Insurance Company (captive or CIC) is a property and casualty insurance company established to provide coverage primarily for a parent company. It can be a valuable risk management tool which allows businesses to more effectively manage corporate risks of all kinds.
Captives often are set up to insure enterprise risk, risk for which commercial insurance is not available or may be too expensive. In many cases, the owner of the parent company is also the owner of the captive; however, the arrangement may be alternatively structured so the captive is owned directly by the operating company, another person, entity, or trust.
The captive insurance company must act as a legitimate business entity and must remain in compliance with all insurance regulatory provisions and Internal Revenue Service requirements.
A captive insurance company may be established to provide unique coverage or coverage not available through commercial property and casualty insurance companies. Coverage underwritten through and insured by a captive insurance company is often best utilized as a supplement to existing coverage, providing a more effective total risk management program for the business owner.
The captive insurance arrangement may also be implemented in order to allow the captive owner to capture overhead, profit and other capital which would normally transfer to another insurance carrier. The risk management consultant will review existing policies, identify gaps in coverage and recommend potential areas of exposure.
Once the desired insurance risks have been identified, an actuarial company will be retained to determine an appropriate premium for the risks assumed by the captive, which will in turn provide coverage for the named risks.
In these uncertain times, the successful business owner faces the pressure of multiple risks in their daily operations. Examples of these risks include: loss of a business license or professional license, adverse financial impact of regulatory or legislative changes, loss of a key vendor or major client, loss of franchise license or lease, environmental losses, regulatory inspection failure, etc.
Small to mid-size privately held businesses can benefit from risk management tools that can help them more effectively manage such enterprise risks and control their insurance costs. To that end, the business owner should consider establishing their own Captive Insurance Company.
If properly structured and underwritten, premiums paid by the parent operating company to its captive insurance company for property and casualty coverage should be tax-deductible to the parent company as an ordinary and necessary business expense.
A captive insurance company allows the business owner to reserve against property and casualty risks, and other enterprise risks, as noted above. These are often the types of risk that keep business owners up at night and could result in business interruption, loss of revenue or even drive them out of business.
These are risks that the business owner faces every day, but for which insurance coverage may not be available or may prove too costly to obtain. Business owners currently self-insure for risks of this type, or may utilize a reserve account on their balance sheet for this purpose.
To manage these needs, the parent company can create a captive insurance company which will design an insurance program tailored specifically for their unique situation.
In order to successfully implement and manage the captive insurance company, there are a number of professionals who must be engaged to help develop, implement and provide administrative management for the company. Mac Advisory Group will coordinate the efforts of our Best-in-Class independent team of experts to accomplish a turn-key service for our clients with the most experienced team in the industry.
Advantages of Captives
Business owners, corporate executives, entrepreneurs and professionals all have differing needs. Effective captive insurance strategies are built around overall business objectives in both the near and long term. The key is deciding what types of risk the company wishes to retain.
By using captive insurance companies and other risk transfer techniques, disparate types of enterprises have reduced the cost of risk, protected their assets, generated profit and reduced their taxes.
Enhance risk control
This is especially important for middle market companies. By identifying sources of risk, businesses can be made more resilient and improve their agility in both near and long-term planning.
Reduce insurance costs
Using a captive largely eliminates the 35% of commercial insurance premium that covers acquisition costs, overhead and profit. Business owners keep the underwriting profit.
Smooth underwriting cycle.
Businesses value certainty wherever they can find it. The pricing volatility of the commercial insurance market can be drastically reduced by using a captive, leading to greater budgetary stability.
Improve cash flow
Establishing a captive allows more flexibility in premium payment planning. Owners retain premium and investment income, significantly improving cash flows.
Insure difficult risks
A captive can provide ownership with coverage that is difficult or uneconomical to obtain in the commercial insurance market.
Create new profit center
A captive may operate as a separate profit center, underwriting the risks of third parties, such as customers of the core business. Profits and investment income accrue to the captive and parents rather than the traditional insurance market.
Improve tax strategy
Because they report profits differently from other companies, captive insurance companies have significant tax advantages. Dividends distributed at favorable rates.
Loan Backs to parent of excess surplus.
Access reinsurance market
A captive insurance company may be able to buy reinsurance from the reinsurance market. The captive, therefore, can give access to an international wholesale market that is denied to the direct insured.
A flexible program design
Participation in underwriting and investment results
A one-stop, bundled services approach
A properly designed Captive Insurance Company arrangement can provide significant Wealth Accumulation opportunities, and can also allow for efficient and tax-advantaged Wealth Transfer and Asset Protection strategies.
Professionals at Mac Advisory Group will work with your legal and tax advisors, and coordinate the activities of our Best-in-Class professional advisors, to help ensure that your captive arrangement is compliant and meets all requirements for successful implementation.
A captive insurance company established as a stand-alone business entity can offer many additional planning advantages to the business owner, including:
- Estate Planning
- Asset Protection
- Wealth Accumulation
- Business Succession Planning
As noted above, a captive insurance company can be utilized as an effective Wealth Transfer vehicle. For example, a high net worth individual may choose, with the assistance of estate planning counsel, to implement an irrevocable trust for the benefit of his children or grandchildren.
The irrevocable trust may, in turn, own 100% of the captive’s shares, providing an effective mechanism to benefit trust beneficiaries via increases in the captive's overall net worth, resulting from increases in its investment portfolio over time. When owned by an asset protection trust, capital and surplus of the captive insurance company can be protected from litigation risk. This arrangement can play an effective role in protecting assets from future creditor's claims.
Our firm is not permitted to offer, and no statement contained herein shall constitute, tax or legal advice.
You should consult a legal or tax professional on any such matters.