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.
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”. CIC's 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?
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.
What is a Typical Captive Design?
According to industry reports, approximately 90% of the world's captive insurance companies are 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.
Oxford's primary domestic captive structure integrates a highly regulated U.S. domicile 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 $50,000.
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, 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 on a turn-key basis.
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.
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 Research Group, LLC, 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. The information gathered during the analysis will be incorporated into a formal feasibility study and report, 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.
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 set aside a minimum of seven years before taking distributions, dividends, or loans from the captive, and ideally, this time period should be at least 10 years. If the insured maintains a favorable loss profile (the captive is successful in managing claims and expenses) then the captive’s investment portfolio should increase at a high rate, because of the time value of money.
How does a Captive fit into my Overall Estate Plan?
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.
How can a CIC complement an asset protection plan?
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, making it essential to include counsel familiar with asset protection planning in the planning process.