Eight of the most common questions about Captive Insurance are answered. asset-protection (1)

Questions and Answers Regarding Captive Insurance Companies

For those new to the world of captive insurance companies, the following is a basic introduction.  Charlie Davis, one of our attorneys well-versed in Captive insurance companies, prepared the following:

Small Captive insurance companies (“Captives”) are often misunderstood and frequently abused.  At Davis Miles we understand how to implement and utilize Captives for the benefit or our business and professional clients.

Q1. What is a Captive Insurance Company?

Internal Revenue Code Section 831(b) allows companies to form Small Captives. A Small Captive Insurance Company is one that does not receive annual premiums from the companies it is insuring of more than $1,200,000 annually.

Q2. What are the three most important reasons small businesses find Captives attractive?

1. Capital preservation and tax savings.
2. Asset Protection
3. Wealth Transfer to younger generation.

There are many other reasons and benefits to using Captives, but usually one or all of the above three reasons are why our clients originally contact us about Captives.

Q3.  Who should consider forming a Captive?

1. Any business (or the owners of any businesses) where there are substantial business profits, or prospects of substantial business profits and taxable income.

2. Professionals: Doctors, lawyers, architects, engineers, attorneys and law firms, accountants and accounting firms, insurance agencies.

3. Companies where either the business or the owners have substantial exposure to liability claims.

Q4.  If I already have insurance, why would I need a Captive?

First, the Premiums paid to your Captive go to your company and not someone else. Second, the premiums are deductible by your business, but not treated as income to your Captive. So if you are an owner of a business or professional practice and you pay a premium to your own insurance company, the entity that pays the premium reduces taxable income by the premium amount (up to $1,200,000) but that money is not treated by the Captive as taxable income. So, in summary, by use of a Captive to insure legitimate risks, if there are no claims made that would be covered by the Captive policy, you can save up to $435,000 or more that would otherwise be paid in taxes, annually.

Q5. Are there other reasons I should consider a Captive?

Yes. Below is a list of other advantages of a Captive.  Not all of these are present in every Captive. The size of the business, its needs and other factors may dictate which advantages apply and are best for each situation.

1. Cost Control. You may be able to get insurance considerable cheaper through your Captive and/or stabilize your insurance costs.

2.  Abnormal Risks. There may be some risks that you may want to insure against that a commercial insurance company would decline.

3. Captive insurance is often supplemental and secondary to a primary policy. For example, Captive coverage is often secondary or can be designed to cover deductibles, only.

4. If a claim is made against your business, Captives can be effective negotiating tools. Since commercial insurers know that you may keep the insurance in house,

5.  Premium Flexibility.  You can vary premiums, year to year. There may be numerous reasons for doing this:  cash flow needs, cost of commercial insurance varies, etc.

6. Dictate Policy Terms. A big advantage of a Captive is the ability to dictate terms of coverage.  Many businesses like to write litigation expense policies that limit coverage to paying for attorney fees and other litigation costs. But they do not pay claims.  This gives the owner a war chest to fight the suit, but does not create a pot of money for claimants to chase.

7. Increased Claims Control.  Commercial carriers decide when and how to settle claims based on what is in their best interest.  By having a Captive, you retain control over when and how claims are paid, and those decisions can be vital to many business strategies.

8. Save Underwriting Expenses. Commercial carriers operate to make a profit.  That profit potential is built into their premiums.  Additionally they make profits from their investments.  Businesses can often realize significant savings by self insuring certain risks and prudently investing the reserves.

9. Accept Greater Deductibles.  Captives can be used to allow the business to purchase insurance with high deductibles, and the Captive insures the increased deductible. This results in reduced commercial insurance costs, and where claims history is nominal, and allows the Captive to accumulate substantial assets.

10. Access to Reinsurance Markets. Depending on a number of factors, the Captive may be able to purchase reinsurance.  Reinsurance is generally insurance sold by one insurance company to another, and it is sold at wholesale rates.  In effect, your Captive would sell a policy to your company, at retail, then the Captive purchases, at wholesale rate, a policy from the reinsurer to cover it, should it have to pay.  The Captive makes a profit on the spread.

11. Flexibility in Coverage. Commercial policies are generally inflexible and may or may not serve all of your needs.  Captive policies can be custom designed to meet your particular needs and cover risks not that commercial carriers either will not or do not cover.

12. Asset Protection.  Assets of a Captive are generally immune from claims of general creditors of the business.

13. Wealth Transfer.  Because there are a number of ownership options, it is possible to set up Captives so that the value of the Captive is excluded from the estate of the business owners, and hence, not subject to estate and inheritance taxes.

14. Flexibility in ownership.  Ownership can be split along different lines from that of the business.  Or family members or special trusts can have ownership.

Q6. Do I have to go off-shore to form a Captive?
Captives can be formed domestically or utilizing off-shore jurisdictions.  There are a number of considerations in choosing the jurisdiction where the Captive is formed.  We discuss these in detail with out clients so they can make the best choice.  In any event, if it is an off-shore Captive, it is “domesticated” so that for IRS and Homeland Security purposes it is considered a U.S. corporation.  We do not engage or encourage our clients to engage in highly risky off-shore tax strategies.

Q7. How much does it cost to form a Captive?
It depends on a number of factors. But before incurring any costs, we meet with our clients, get an understanding of their needs, and then give them a fixed price.

Q8. I would like to discuss the potential for establishing a Captive Insurance Company.  What should I do next?

Call Charlie Davis, and he will discuss matters over the phone and if appropriate set up an in-office or follow-up telephone appointment to discuss matters in detail. Please call 480-733-6800 (office) or 480-344-4570 (Mr. Davis’s direct number).