Although many think that the concept of captive insurance companies is a relatively new phenomenon, the captive industry can be traced to the 1920s in the formation of mutual and co-insurance companies. However, only during the last 20 years has the captive insurance industry seen exponential growth as sophisticated taxpayers have realized the risk management, insurance savings, wealth transfer, and tax advantages of captive insurance companies. Today, nearly all major corporations utilize captives and take advantage of the numerous benefits they provide.
What Is Captive Insurance?
Captive insurance companies are insurance companies established for the purpose of financing risks emanating from their parent group or groups, although they sometimes also insure risks of the group's customers as well. Using a captive insurer is a risk management technique in which a business forms its own insurance company subsidiary to finance its retained losses in a formal structure. In other words, instead of the common parent purchasing insurance from a large third-party insurance company, the common parent instead sets up its own insurance company to satisfy its insurance needs. Most insurance needs are thereafter taken care of in-house by the captive. The term “captive” comes from the fact that the policyholder owns the insurance company, i.e., the insurer is captive to the policyholder. Therefore, its business is primarily supplied by and controlled by its owners, which are also normally the principal insureds.
How Can a Captive Help?
Captive insurance companies can potentially benefit taxpayers in a number of ways:
Insurance Savings: The first benefit of a captive insurance company is the potential for insurance savings. If the captive's underwriting is successful, the business owner will gather the underwriting profits. Additionally, the business owner may be able to add coverages that are otherwise unavailable or which are prohibitively expensive if purchased on the open markets. The business owner may also be able to use a captive as a tool to leverage insurance brokers into offering commercial coverages at lower rates.
Income Tax Savings: Captive insurance companies can also offer dramatic income tax savings because they allow the business owner to reserve for claims on a pre-tax basis. The use of the captive insurance company essentially creates a tax deduction to the operating business that would otherwise have been unavailable. Small captive insurance companies can accept up to $1.2 million/year in insurance premiums tax exempt! If the risks that are insured against never materialize, the captive insurance company makes a profit and the operating business keeps its deduction.
Wealth Transfer: Captive insurance companies also offer the potential for wealth transfer to successive generations without the payment of gift or estate tax. This is because the payment of premiums is considered the purchase and sale of insurance, and not a gift. If the captive is owned outside of the business owner's estate, then all underwriting profits from the captive's insurance activities will be earned outside of the estate. Moreover, the investment growth of the captive's reserves and surplus will also be outside the estate.
alliantgroup can assist you in the consulting aspects of your captive insurance needs, from conducting a feasibility analysis to conducting a review of your current captive insurance for compliance and audit readiness to full defense, buildout, and substantiation of your captive in IRS examination.
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