What is a Captive?
A Captive Insurance Company is a Property and Casualty Insurance Company that is formed to cover risks of its parent company. 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.
What are the Advantages of a Captive?
In addition to cost effective risk management, Internal Revenue Code 831(b) provides significant tax advantages for small insurance companies (Captives). As long as annual premiums are $1.2 million or less, the captive should not pay federal income tax on premium 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 70% of the dividends it receives from taxable income.
How does a Captive fit into my Overall Estate Plan?
A captive insurance company is not an estate planning tool. However, the establishment of a captive insurance company can complement your estate plan. One of the advantages of flexible captive ownership is the ability to create CIC shares in your children’s name, or in an irrevocable trust, outside of the taxable estate. You should discuss captive creation strategies with your estate planning counsel to assure that the most appropriate structure is utilized to fit your estate planning objectives.
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”. CICs 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.