What Is a Captive Insurance Company?
Simply put, a Captive Insurance Company is a closely-held insurance company that insures primarily, but not exclusively, your business. It is a C corporation and is licensed and domiciled like any large insurance company but, unlike a large insurance company, the owners are able to shelter up to $2.3 MILLION DOLLARS EACH YEAR as an expense to their main business.
Captives have their own reserves, policies, policyholders and share 51% of claims with a separate insurance risk pool made up of other privately held Captive Companies with similar risk and claims histories (i.e. A $100,000 claim on a bond would cost your Captive $49,000 while the other $51,000 is covered through the risk pool required by the guidelines for Captive Insurance Companies.
Insurance policies are issued by the Captive to its parent or related companies and are actuarially priced accordingly to the underlying risk by independent insurance actuaries. Owning a Captive Insurance Company is a sophisticated way to self-insure, and Captives are generally formed to insure the risks of a business, group of businesses and related or affiliated third parties.
How Does Captive Ownership Enable You to Protect and Build Wealth?
Simply put, a Captive Insurance Company is a powerful risk management and wealth accumulation tool. By operating their own insurance company, business owners and CFOs can:
- Avoid Sunk Cost of Third-Party Insurance: Currently, if you pay insurance premiums greater than $250,000 per year, you can eliminate this expense by paying those premiums to your own Captive and have your company’s existing insurance coverages underwritten by Liberty Mutual Insurance. Premiums paid to your Captive Insurance Company remain the property of the Captive owners and are retained as profit.
- Gain Access to a War Chest: Over time, assets are accumulated in a Captive tax free and if positioned correctly, income from the Captive can be distributed tax free. Because the Captive is a formal form of self-insurance, it benefits from insurance law and favorable tax treatment. Hence, it is able to accelerate asset accumulation.
- Utilize Customizable Coverage: Captive Insurance Companies can write customizable coverage for the businesses they insure. Many businesses face unique risks that may not be addressed by commercial insurers. The flexibility afforded by a Captive is extremely beneficial in a complex world.
- Fill Third-Party Gaps: A Captive Insurance Company can issue insurance policies that address gaps not covered by third-party insurers.
- Benefit From Few or No Policy Exclusions: Captives can provide broad coverage without the exclusions that riddle typical commercial insurance policies. Insurance coverage is worthless if an exclusion prevents the insured from receiving a claims payment when it needs it most.
How Wealth is Accumulated
First, premiums paid to the captive receive favorable tax treatment (No taxes on contributions up to $2,300,000 per year). Premiums paid to the Captive are an expense to the parent company. This lowers the parent company’s taxable income. As the Captive takes in premiums, it is taxed as an insurance company on its underwriting profits (typically defined as premiums less reserves to pay future claims). For large insurance companies, underwriting profit is actuarially determined. However, small insurance companies can make an 831(b)-tax election, resulting in a tax rate of zero percent on their underwriting profit. A small insurance company is defined as receiving premiums of $2.3 million or less per year.
Second, the Captive is able to invest and grow a larger pool of assets. Large commercial insurers have entire staffs whose sole purpose is to invest reserves (that have not been taxed). If positioned correctly, this money can be distributed tax free using our hedging strategy.For these reasons, a well-run Captive Insurance company will typically double be retained earnings. And, the same claims that would be paid by the captive would have to be covered out of retained earnings anyway if the captive weren’t in place.
Enjoy the Ability to Reap Long Term Profits
When business owners are ready to sell their business or retire, they keep the war chest and receive distributions tax free. A successful captive amasses wealth for its owners that can be accessed and enjoyed in the future. Captives have the unique ability to improve risk management and simultaneously stockpile wealth.