Captive Insurance Explained for Business Owners

Captive insurance is a type of insurance company that's owned and controlled by a single business or group of businesses. It's a way for companies to self-insure and manage their own risks.

A captive insurance company is usually set up to cover the risks of its parent company, such as liability or property damage. This can be a cost-effective way for businesses to manage their risks, as they can avoid paying premiums to external insurance companies.

By setting up a captive insurance company, businesses can also have more control over their insurance policies and can tailor them to their specific needs. For example, a company that operates in a high-risk industry may be able to create a captive insurance company that provides specialized coverage for its unique risks.

Captive insurance is a type of insurance company that's owned by a single business or group of businesses. It's a way for companies to manage their own risk and save on insurance costs.

Captive insurance companies are typically created to cover specific risks or liabilities, such as product liability or workers' compensation. They can also be used to cover broader risks like property damage or employee theft.

By self-insuring through a captive, companies can avoid paying premiums to third-party insurance companies and instead use the money to fund their own risk management programs. This can be a cost-effective way to manage risk, especially for companies with unique or high-risk operations.

Captive insurance companies are regulated by state or national insurance authorities, just like traditional insurance companies. They must meet certain capital requirements and follow strict accounting and reporting standards.

In some cases, captive insurance companies can be used to reduce tax liabilities or provide additional benefits to company owners or employees. However, these benefits must be carefully structured and approved by tax authorities to avoid any potential tax implications.

Captive insurance companies offer a range of benefits to their parent companies or related entities. One of the main advantages is lower insurance costs, which can be achieved by self-insuring or reinsuring risks.

Some organizations have turned to captives as a way to fund non-insurable risks, retain more risk through a formal mechanism, and stabilize risk financing costs over time. This can be particularly useful in challenging insurance market conditions.

Captive insurance companies can provide tax advantages, underwriting profits, and greater control over coverage. This can be especially beneficial for companies with unique risks that are difficult to insure in the commercial market.

Most Fortune 500 companies today have captive insurance companies, indicating their popularity and effectiveness. However, captives also come with drawbacks, such as overhead expenses and compliance issues.

Here are some specific benefits and uses of captive insurance companies:

Captives are subject to licensing requirements, and in some cases, they must initially be written by another insurer, which then reinsures them to the captive.

The original insurer retains a fee, usually between 5% and 15%, to provide this service.

Premiums paid to captives are tax deductible, provided the terms of the policy are reasonable.

A captive cannot arbitrarily set the premium amount simply to generate a deduction for the parent.

In the US, workers' compensation insurance must initially be written by another insurer, which then reinsures it to the captive, retaining a fee between 5% and 15%.

Captives can write some lines of business directly, but they must follow the terms of their policy, including the premium amount, which must be reasonable.

Premiums paid to captives are tax deductible, but the captive cannot arbitrarily set the premium amount to generate a deduction for the parent.

In the European Union, a new set of regulatory requirements, Solvency II, is planned with additional restrictions and responsibilities for captives and reinsurance companies.

Some European captives ask for simplified regulation, which suggests that existing rules may be too complex or burdensome.

Tax Issues are a crucial consideration for businesses looking to establish a captive insurance company. The tax concept of a captive insurance company is relatively simple.

To qualify for tax benefits, a captive insurance company must demonstrate risk distribution and risk shifting, as mandated by the Internal Revenue Service (IRS). The IRS has publicly declared it would take action against captive insurance companies suspected of abusive tax evasion.

Several U.S. states allow the formation of captive companies, offering protection from tax assessment. But whether a parent company realizes a tax break depends on the classification of insurance handled by the captive company.

Single events are less likely to bankrupt a large private insurer due to the diversified pool of risk they hold.

Captive insurance companies come in various forms, each serving a specific purpose. Let's break down the different types of captives.

There are six primary types of captive insurance companies: Pure Captive Insurance Company, Protected Cell Captive Insurance Company, Special Purpose Captive Insurance Company, Association Captive Insurance Company, Industrial Insured Captive Insurance Company, and Special Purpose Financial Captive Insurance Company.

Here are the different types of captives in a concise list:

Additionally, there are two other forms of captive insurance: Risk Retention Group and Branch Captive Insurance Company.

Captive insurance companies come in various forms, each with its own unique characteristics.

A Pure Captive Insurance Company is a type of captive that insures the risks of a single parent company or affiliate.

Protected Cell Captive Insurance Companies consist of a core and an indefinite number of cell entities, each with dedicated assets and liabilities.

Special Purpose Captive Insurance Companies are captives that don't fit into any other category and are designated as such by the Commissioner.

Industrial Insured Captive Insurance Companies insure the risks of industrial insured groups and their affiliated and controlled unaffiliated businesses.

Special Purpose Financial Captive Insurance Companies are formed to reinsure the risk of an affiliate or parent, usually a life insurance company.

Micro-captives, also known as Section 831(b) or "small" property/casualty captives, are used by midsize companies to transfer risk and provide cost-effective insurance solutions.

Over 90 percent of Fortune 1000 companies and many middle market businesses have captives, with over half of all property and casualty premiums written through captives.

Here are the main types of captive insurance companies:

A Branch captive insurance company is a type of captive insurance company that operates in a specific state, including North Carolina. It's licensed by the Commissioner to transact the business of insurance in this state through a business unit with a principal place of business in this state.

A key characteristic of a Branch captive insurance company is that it's a pure captive insurance company with respect to operations in this state, unless otherwise permitted by the Commissioner. This means it primarily insures the risks of its parent and affiliated companies or a controlled unaffiliated business or businesses.

To be more specific, a Branch captive insurance company is considered a type of captive insurance company that is licensed to operate in the state. It's not a standalone entity, but rather a business unit of a larger organization.

Here are the types of Branch captive insurance companies:

A domicile is the primary jurisdiction where a captive insurance company is licensed. Bermuda is the world's leading offshore captive domicile.

Bermuda's favorable reputation and geographical location made it an attractive choice for Reiss, who sought a jurisdiction that would allow his captive concept to flourish. The Cayman Islands is the second largest licensing jurisdiction in terms of the number of captives licensed.

Vermont is second in terms of insurance company assets but third in terms of captives licensed in the United States. Healthcare corporations prefer Bermuda, due to the ease of claim payment provided by the regulatory environment.

Luxembourg is the largest captive reinsurance domicile in the EU. A recent trend has various states in the United States revising their regulations to be more attractive to captive insurance companies.

Here is a list of the top captive domiciles, ranked by the number of captive companies licensed:

Other notable captive domiciles include Delaware, Ireland, and the British Virgin Islands, which have fewer captives licensed compared to the top five.

A Risk Retention Group is formed pursuant to the Liability Risk Retention Act of 1986. They are restricted to writing only liability coverage.

One notable aspect of Risk Retention Groups is that once licensed in one state, they may operate nationwide provided they properly register with all other states in which they propose to solicit or write insurance.