Why captive

For many years, large corporations in this country have enjoyed many benefits from operating their own captive insurance companies. Most were established to provide coverage where insurance was unavailable or unreasonably priced.

These insurance subsidiaries or affiliates were often domiciled offshore, especially in Bermuda or the Cayman Islands. The risk management benefits of these captives were primary, but their tax advantages were also important. In recent years, smaller, closely held businesses have also learned that the captive insurance entities can provide them significant benefits.

These include the attractive risk management elements long appreciated by the larger companies, as well as some attractive tax planning opportunities. A properly structured and managed captive insurance company could provide the following tax and nontax benefits:.

Since captives became accepted in the United States, a number of types have evolved. For the premium payment to the captive to be deductible as an insurance expense, the captive must be able to prove that it is a valid insurance company payments for self-insurance generally are not deductible L. Thompson Scenic Railway Co. Besides obtaining an insurance license from a state or a foreign jurisdiction, the captive must provide insurance to the operating company or its affiliates.

Insurance was defined for tax purposes in Helvering v. LeGierse , U. To meet the risk-shifting requirement, the operating company must show that it has transferred specific risks to the insurance company in exchange for a reasonable premium. In Kidde , 40 Fed. Risk distribution occurs when particular risks are combined in a pool with other, independently insured risks. By increasing the total number of independent, randomly occurring risks that a corporation faces i.

Thus, the captive must be accepting risks from multiple separate entities to satisfy this requirement.

The IRS has issued a number of revenue rulings that provide guidance to captives to ensure compliance with these factors see, e. In addition, in Rev. There is one additional requirement for the captive to be considered an insurance company for federal purposes.

The formation of a captive insurance company is a lengthy process including feasibility studies, financial projections, determining domicile, and, finally, preparing and submitting the application for an insurance license. The need for a qualified insurance manager on the planning team is very important, particularly in the formative stages. The requirement for adequate initial capitalization of the captive is dependent in part on the level of risk projected to be assumed by the captive and the requirements of the particular domicile chosen.

In some cases, this initial capitalization can be accomplished through the use of irrevocable letters of credit. The irrevocable letter of credit would be obtained by the sponsor applying to the bank for this letter of credit.

One critical function to be performed during the formative stages is the identification of the risks to be insured by the captive. The operating company is presently paying premiums to one or more commercial insurance companies to protect it from specific risks, some of which could be catastrophic if they were to occur without such insurance.

Should the captive see a need to protect itself in the case of a higher-risk policy, it may be able to buy reinsurance at premiums that are less than the premiums that it has charged the parent company.

On an annual basis, the premiums paid to the captive in excess of its claims and operating expenses will transfer to the earned surplus account and be available for more aggressive investment activities. As was pointed out in Rev. In that case, payments into the captive would take on the aspects of deposits into a sinking fund to help liquidate an existing liability.

One of the risk management benefits that the captive may provide is the flexibility to opt for higher deductible levels on the existing property and casualty insurance policies.

In keeping with the above desire to minimize, but not eliminate, claims experience, the selection of the risks that the captive is willing to assume should be prudent. The attractive tax benefits associated with the smaller captives can sometimes cause business owners to forget that the captive must operate as a true insurance company.

The use of an experienced and capable captive management company is an essential element of the normal operations of such an entity. The need for annual actuarial reviews, annual financial statement audits, continuing tax compliance oversight, claims management, and other regulatory compliance needs puts the day-to-day management of a captive insurance company beyond the skills of most general business people. We offer a full suite of services to support this model —including management guidance, operational support, and strategic captive insurance expertise to a portfolio of over 40 group captives comprised of more than 5, members.

How we execute is what really gives our clients the edge. Here are just a few of the reasons why our captive clients and their members love working with CRI. Our innovative member-owned group captive model gives the group captives we work with unparalleled control, customized pricing, and access to best-in-class risk control and safety resources. Unlike traditional insurance companies that offer limited and typically inflexible services, a CRI-administered captive can more readily alter its support services without undue disruption or extra costs.

By joining a group captive, companies enjoy new-found buying power and clout. The member-owned group captives we work with have strong relationships with numerous fronting and reinsurance carriers, as well as claims administration and loss prevention companies. You will need help from qualified risk managers, a captive manager, accountants, and attorneys to determine the best options for your company.

An insured considering a captive will need sufficient financial resources to support the capital investment and the posting of collateral behind the captive program. Captives are a way for companies to reduce reliance on the commercial market and provide stable, long-term risk financing. Captives will not be the lowest cost option in all years, so to be successful, they will need to be committed to the process long term.

Short-term premium savings should not be the overriding reason for starting a captive. Generally, an organization should be willing to commit at least three to five years to a captive arrangement. Your browser is out-of-date! It has known security flaws and may not display all features of this and other websites. Learn how.

Skip to main content. Reasons to form a captive To reduce or stabilize insurance costs Financing risk in a captive makes sense for a smaller, more homogeneous group of insured businesses with more favorable claims experience than the broader insurance market. To increase capacity for offer tailored products and access to reinsurance Businesses insured in the traditional market are limited to coverage, deductibles, and limits offered by insurance companies, a "one size fits all" mentality.

To control insurable risks Traditional insurers are subject to the cycles of hard and soft insurance markets.

To establish better-than-average claim experience A company with a favorable claims history may be a prime candidate to establish a captive to avoid subsidizing other insured businesses with less favorable claims experience.

Safety and soundness for risk management programs The captive insurance market is more formalized than self-funding insurance risk and has a regulatory framework to support the captive for example, a requirement for annual audits and actuarial opinions on adequacy of reserves.

Is a captive right for my organization? How does your claims experience compare to the average? Is your current claims experience consistent and predictable?