There are numerous potential advantages to forming a captive insurance company. Captive insurance companies are formed for both economic and risk management purposes. For example, by forming a captive insurance company, a business can dramatically lower insurance costs in comparison to premiums paid to a conventional property and casualty insurance company. By establishing one’s own insurance vehicle, costs for overhead, marketing, agent commissions, advertising, etc., may result in significant savings in the form of underwriting profits, which can be retained by the owner of the captive company.
Additionally, a captive insurance company can provide protection against risks which prove to be too costly in commercial markets or may be generally unavailable. The inability to obtain specialized types of coverage from commercial third-party insurers is another reason why clients may choose to establish a captive insurance company. With a captive insurance company, a business owner can address their self-insured risks by paying tax deductible premium payments to their captive insurance company. To the extent the captive generates profits, those dollars belong to the owner of the captive.
In most cases, to the extent existing P&C coverage is reasonably priced, business owners will continue to maintain existing policies for their traditional coverage and supplement existing coverage by addressing their self-insured risks with their own captive insurance company. Policy features, coverage and limits can be drafted to meet specific enterprise exposures. This allows for many risk-management advantages, including:
- Greater Control over Claims
- Increased Coverage
- Increased Capacity
- Underwriting Flexibility
- Access Reinsurance Market
- Incentive for Loss Control
- Reduced Insurance Costs
- Capture Underwriting Profit
- Pricing Stability
- Improved Claims Review and Processing
- Purchase Based on Need
- Tax Benefits
- Investment Income
- Additional Profit Center
In general, your captive insurance company will be capable of delivering better service to your operating company than a commercial insurance company can. The feasibility analyst team at Oxford Risk Management Group will help you to determine the best balance between coverage retained from commercial carriers and your captive insurance carrier.
Oxford Risk Management Group will coordinate the services of a captive manager, risk manager and actuary to determine an appropriate amount of premium to be paid for the coverage being provided. Premium payments made by the operating company to the captive insurance company for property and casualty insurance coverage should be tax-deductible as an ordinary and necessary business expense, just as they would be treated had they been made to a traditional insurance company.
Internal Revenue Code Section 831(b) provides that captive insurance companies are taxed only on their investment income, and do not pay income taxes on the premiums they collect, providing premiums to the captive do not exceed $1.2m per year. Legislation signed into law on December 18, 2015 has increased the premium limitation from $1.2m to $2.2m per year for taxable years beginning after December 31, 2016. This new limit will be indexed for inflation annually, and has been increased to $2.3m annually for tax year 2018.
Further, the captive may retain surplus from underwriting profits within reserve accounts, free from income tax. It can also generate profits by controlling or eliminating costs for overhead, marketing, advertising, agent commissions, profits, etc., items normally built into the premiums charged by traditional insurance companies. After adjustment for expenses and claim payments, net underwriting profits are retained within the captive insurance company. Over the years, profits and surplus may accumulate to sizeable amounts, and may be distributed to the owner(s) of the captive company, under favorable income tax rates as either dividends or long-term capital gains.
Amounts set aside as reserves for potential claims payments, plus capital surplus, should be maintained in safe, liquid asset classes so that the captive has adequate solvency to pay claims when called upon. The formation of your Captive Insurance Company and eventual issuance of a certificate of authority to do business, are subject to approval by the insurance regulators in the jurisdiction where the insurance captive is formed. The insurance regulators will also oversee the organization and ongoing operation of the captive insurance company to assure ongoing compliance with the rules for that jurisdiction.
The new 2015 tax legislation adds diversification requirements to the 831(b) eligibility rules. A company can meet these rules in one of two ways – allowing for continued enjoyment of captive benefits and section 831(b) eligibility. Ownership options for your captive remain very flexible, but requires the assistance of competent advisors and an efficient captive structure to assure compliance with the new eligibility rules.
A properly designed Captive Insurance Company arrangement can provide many advantages for the insured enterprise and the owner(s) of the captive. Professionals at Oxford Risk Management Group will work with your legal and tax advisors, and coordinate the activities of our Best-in-Class professional advisors, to help ensure that your captive arrangement is compliant and meets all requirements for successful implementation.