What is Captive Insurance?
A captive insurance company is a Property and Casualty insurance company that is formed to cover risks of its parent company and related entities. Captive insurance is a risk management tool which allows businesses to more effectively and efficiently manage corporate risk. Captives often are set up to insure enterprise risk, risk for which commercial insurance is not available or may be too expensive.
Are Captives New to the Marketplace?
Captive insurance is not a new concept. The concept of a business forming a wholly-owned insurance company which would insure its owner’s risks can be traced back to the group of London merchants who lost their assets in the Tooley Street fire in 1861. The concept continued in the 1920s when several corporations with multi-national interests, including British Petroleum, Unilever and Lufthansa each formed wholly-owned insurance companies. The late Fred Reiss conceived and marketed the concept of a wholly-owned insurance company which he called a “captive”. Captive insurance companies have stood the test of time since 1957 when Reiss formed his first captive in Cleveland, Ohio for the Youngstown Sheet and Tube Company. Most Fortune 500 companies have their own Captives. Thousands of small companies have also set up captive insurance companies. What is different today is that a client can enjoy a conservative structure within a highly regulated U.S. Domicile with reasonable cost, or they can also enjoy a conservative international structure offering economies of scale that allow captive implementation on a very cost efficient basis.
What Type of Company can benefit from a Captive Insurance Company?
Captive insurance companies can suit a wide range of companies. Large corporate structures often benefit from creating a wholly-owned captive, or “pure captive” to insure risks suitable for the organization’s business needs. Smaller companies can benefit from captive insurance planning by insuring enterprise risk, exposures for which commercial insurance is not available, or may prove too costly via traditional insurance carriers. Enterprise risk is usually an uninsured risk, but a business owner cannot take a tax deduction for that risk without setting up a captive insurance company.
What are the Advantages of a Captive Electing 831(b) Treatment?
In addition to cost effective risk management, Internal Revenue Code 831(b) provides significant tax advantages for small insurance companies (Captives). As long as 2021 annual premiums are $2.4m or less, (increased for inflation from $2.2m in 2017 to $2.3m in tax year 2018) the captive should not pay federal income tax on premium income and will only be taxed on investment income. Further, underwriting profits and reserve accounts remain tax free. Investment income is taxable to the captive insurance company at graduated corporate rates. Dividends distributed from the captive, if any, should be taxed at long-term capital gains rates as a qualifying dividend.
What Investments Can a Captive Own to Provide Reserves?
A captive can own any investment approved by the insurance regulators in the jurisdiction where the captive insurance company is domiciled. It is important for the captive to maintain appropriate liquid reserves in order to meet potential claims liabilities. Therefore, captive insurance companies are highly regulated, and investment portfolios tend to be conservative and provide significant liquidity. Oxford works closely with the insurance regulators in each domicile, to ensure that captive investment portfolios are conservative and provide adequate liquidity to allow for payment of claims and expenses.
Investment Plans for captive insurance companies are typically structured in a manner which will reduce exposure to taxation from investment income. It is not uncommon for the captive investment manager to incorporate tax-free municipal bonds and other asset classes generating annual dividend income. The Dividends-Received Deduction under U.S. federal income tax law, provides that the captive can exclude 50% of the dividends it receives from taxable income.
What is a Typical Captive Design?
According to industry reports, approximately 90% of the world’s captive insurance companies were previously domiciled outside of the U.S. Among the advantages of an offshore captive are less intrusive and more consistent regulatory oversight, a broader range of acceptable investment options, and the potential for significantly lower implementation costs and ongoing expenses. During the past few years a significant percentage of new captive implementations were domiciled in the U.S.
Oxford’s primary domestic captive structures integrate several highly regulated U.S. domiciles with very cost efficient economies of scale. Oxford’s primary international captive structure mirrors the highly conservative domestic platform; contemplating client elections to be taxed as a U.S. taxpayer. Conservative international captive models designed by Oxford’s team allow for cost efficient annual planned premiums as low as $100,000.
The company considering forming the captive must have the financial resources to contribute to the captive insurance company. All jurisdictions have minimum capital requirements for captive insurance companies, and successful operations require the services of numerous professionals such as lawyers, risk managers, actuaries, accountants, etc., to assist with the creation and provide ongoing maintenance of the captive. A captive management company will be retained to coordinate the activities of the other professional, provide claims review services, and manage the day-to-day operations.
What Kinds of Captives does Oxford Offer?
Oxford Risk Management Group has extensive experience with all kinds of captives, including Stand-Alone, Protected Cell, Series and Group. While they can be similar in design and effectiveness, there are several distinct differences. Stand-Alone captives offer their owner the greatest degree of control and design flexibility. However, their higher implementation, management and capitalization costs should be weighed against it’s benefits.
Oxford Cell or Series captives are operated subject to guidelines established by the plan sponsor, generally under a pre-established structure. Captive assets are generally held in separate accounts with statutory protection from one another, offering independent investment advisor and ownership flexibility. Reduced costs can be a significant advantage when compared to Stand-Alone designs.
Oxford offers Group captives, providing options for managing General Liability, Commercial Auto, Workers Compensation and Enterprise risk exposures. When considering eligibility for standard lines of coverage, a client should be paying approximately $250,000 or more in combined premiums to their insurance carriers, and have exceptional loss experience.
Regardless of the form your captive takes, you will need to meet risk distribution and risk transfer requirements. While there are very few real differences between these structures, the professionals at Oxford will help you understand the advantages of each type so that you are in the best position to make an informed choice, suitable for your unique situation.
What Jurisdiction Should I Select for my Captive Insurance Company?
There are many excellent jurisdictions to consider, offshore as well as, within the U.S. In addition to the domicile considerations noted above, geography should be added to the list. You may be required to travel to the jurisdiction to perform any implementation activities and physically form the captive insurance company. Additionally, many jurisdictions require the captive to have at least one meeting per year within the jurisdiction, along with a registered agent and a physical address. There are numerous domiciles offering attractive captive statutes, with excellent regulatory oversight, respected courts, significant case law and corporate law expertise in a stable environment. Several jurisdictions allow for captive design and formation with efficient, cost-effective structures. Consult with experienced captive managers, respected in their respective domiciles, when considering which jurisdiction may be best for your program.
How Can I Find Out if a Captive Insurance Arrangement is Right for Me?
In order to make a determination if a captive insurance arrangement is desirable, Oxford Risk Management Group will facilitate the preparation of a feasibility analysis. This is an analysis which includes input from actuaries, attorneys and risk managers. The purpose is to analyze the parent company’s risk profile and financial position to determine the appropriate type of insurance policies to underwrite along with an analysis of the legal environment for the proposed captive domicile and financial projections for the captive that the company is forming.
Information will gathered from a variety of sources, including the clients senior management team, insurance advisor, independent tax and legal counsel. Data gathered during this analysis will be reviewed by the Oxford team, who will then offer suggestions and benchmark pricing for each line of coverage to be considered. The client will then meet with their team to determine the best coverages suited for their captive policy. Data will ultimately be incorporated into a formal feasibility study and report prepared by our independent actuaries, to be submitted to the insurance regulatory team along with the business plan, as part of the review process for potential captive formation.
Prior to implementation of your captive insurance company, we will provide review services to make an initial assessment of the potential viability of a captive for your situation. In the event a captive insurance company would meet your goals and objectives, you will engage the services of legal counsel to draft the necessary documents and seek regulatory review by the insurance department of your selected jurisdiction, prior to implementation. The insurance department regulators will work with your implementation team to review and approve the structure, coverage, policy language, pricing and captive business and investment plans, as appropriate. Always consult with and seek guidance from your independent tax counsel.
What is the Time Horizon for a Captive?
Any company considering forming a captive should have a long-term plan for the proper development and implementation of a captive program. Once the captive insurance company is established, an organization should consider modifications to their program as business and financial situations change. The insurance advisory team should meet at least annually to evaluate all aspects of the program to ensure ongoing success and benefits. If the insured maintains a favorable loss profile (the captive is successful in managing claims and expenses) it is possible for the captive’s investment portfolio to increase significantly over the years, because of the time value of money.
How does a Captive fit into my Overall Financial Plan?
The 2015 Protecting Americans against Tax Hikes (PATH) Act raised the annual 831(b) premium limit to $2.3m, currently adjusted to $2.4m, and also introduced new diversification requirements for 831(b) eligibility. These new rules were in part enacted to address potentially abusive captive arrangements focused exclusively on wealth transfer – estate planning objectives, rather than risk management and sound business purpose. A captive insurance company is not an estate planning tool. However, the establishment of a captive insurance company can complement your estate plan. Always consult with knowledgeable legal and professional advisors when considering ownership arrangements for your captive insurance company, to assure that the most appropriate structure is utilized to fit varying planning objectives. You should also meet with your existing or proposed captive management firm and your independent tax counsel to fully understand the new qualification tests for 831(b) arrangements contained in the PATH Act
How can a Captive complement my Asset Protection Plan?
A captive insurance company is not an asset protection tool. Nevertheless, with litigation activity on the rise, it can be beneficial to grow some portion of wealth in an entity that provides protection from judgment creditors. The captive insurance company may be owned by an asset protection trust, further safeguarding those dollars from potential litigation exposure. Asset protection rules vary by jurisdiction, and when combined with new captive ownership restrictions signed into law December 18, 2015, make it essential to include counsel familiar with asset protection planning in the planning process. You should also meet with your existing or proposed captive management firm and your tax counsel to fully understand the new qualification tests for 831(b) arrangements contained in the PATH Act