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How Can a Captive Benefit Your Clients?

For over a century, captive insurance has been a viable insurance solution for business owners. Formerly reserved only for the largest corporations, captives have evolved to meet the needs of nearly every operation, including small businesses. As the traditional insurance markets tighten, more and more companies are turning to captives as a solution. There are significant advantages associated with captive insurance; in this guide, we will explore the benefits of captives to share with your clients.

What is a Captive?

Captive insurance is a self-insurance entity formed and owned by a parent company or group of companies for the sole purpose of insuring the owners’ risks. Captives can insure the same risks as a traditional insurer, including general and professional liability, workers’ compensation, and property insurance. Captives can also insure special risks – particularly those that are unavailable or prohibitively expensive in the commercial insurance markets.

Numerous captive insurance models exist, including:

  • Single-parent captives
  • Group captives
  • Protected cell captives (PCCs)
  • Association captives
  • Rent-a-captives
  • Risk retention groups (RRGs)

Each of these captives is best suited for specific applications, and all have significant benefits for business owners.

Benefits of Captive Insurance

For business owners that are seeking alternatives to the traditional insurance market, captives represent a viable path forward. There are six primary benefits of captive insurance:

  1. Availability – captives can provide insurance coverages when traditional insurers cannot or will not, particularly for hard-to-place risks.
  2. Cost Savings – captives often provide the same or superior coverage as traditional insurance, but at a substantial cost savings.
  3. Stability – captives are relatively immune from fluctuations in the insurance markets in terms of pricing and availability.
  4. Control – companies gain an impressive amount of control over insurance, including flexibility, costs, and available coverages/coverage limits.
  5. Transparency – because the parent company or group self-insures, they can manage claims by analyzing claims and loss data to improve insurance performance. This is a valuable risk management benefit, helping to understand and mitigate risks before they can result in expensive claims.
  6. Access – captives gain access to the reinsurance market, which can further lower overhead expenses.

Tax and Profits Benefits of Captives

As illustrated above, captive insurance provides very real benefits for business owners. Captives also offer enticing tax advantages as well as the ability to return underwriting profits to the parent company or group.

A properly established and structured captive insurance entity provides tax benefits like:

  • Annual deductions for premium payments paid to the captive by the parent company.
  • Income tax savings for both parent and captive.
  • Gift and estate tax savings for captive insurance shareholders.

It is important to note that the Internal Revenue Service (IRS) requires risk shifting and risk distribution to be present for the captive to be considered a legitimate insurer. In other words, captives formed solely for the purpose of gaining tax advantages – not to provide insurance for a parent or group — may result in steep regulatory penalties.

In the captive insurance model, the parent company or group/association makes annual premium payments. In years of low claims volume, underwriting profits are returned to the parents. Again, these profits are distributed to the owner(s) of the captive under favorable income tax rates and may be distributed as capital gains or dividends. By adhering to risk management practices, thus reducing the frequency and severity of claims, profits may accumulate.

Considerations for Clients

Captive insurance provides insurance protection for nearly every type and size of business operation. This alternative to the traditional market offers flexibility, tax benefits, and control not found in the traditional market. It sounds like the perfect solution – and for many business owners, captives are. Still, there are three factors a client should consider when determining if a captive is right for their insurance needs:

  • Financial risks – by putting its own capital at risk when establishing a captive, an expensive claim or a series of claims over a short time period puts that capital at risk of loss. In severe cases, members of a captive may struggle to find sufficient funding to cover excessive losses.
  • Service and quality issues – owning and managing a captive requires specialized experience. Failure to adequately address the responsibilities of day-to-day management may result in financial losses and increased regulatory scrutiny.
  • Entrance and exit hurdles – the costs associated with establishing a captive can be steep. These costs include regulatory compliance, licensing, and capital funding. When a captive no longer works for the parent company, leaving may be as difficult as starting the captive in the first place; companies leaving a captive run the risk of being under- or uninsured until a suitable insurance alternative is found.

By carefully assessing these factors, analyzing current and future insurance needs, and by exploring the many benefits possible with captive insurance, companies can make smart financial decisions. Captives continue to gain acceptance by companies around the world – as an alternative to traditional insurance markets, this solution shows great promise.

About Caitlin Morgan Captive Services

Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.