CAPTIVE INSURANCE PROGRAMS

A captive insurance program is, in its simplest form, a wholly owned insurance subsidiary of an organization/company (parent) that insures all or part of the risks of its parent.

Captives are usually formed by companies when business insurance for a certain commercial risk cannot be obtained through traditional insurance markets. They are usually monitored by a risk manager or an officer at the parent company. Most are managed by a captive insurance management company, located within the domicile of the captive.

While there are several tax advantages to hiring a captive insurance company, proper planning is especially important to identify and maximize any available tax advantages and avoid any risks that may detract from the many non-tax advantages of the captive.

Captive insurance benefits

The business reasons for creating a captive insurance company include the following:

Obtaining coverage when commercial insurers are unwilling. Commercial insurance companies often will not provide some types of coverage. For instance, risks that are currently uninsurable frequently involve environmental issues, such as hazardous waste and pollution. Captives can be used to provide coverage in these areas.

Reduced premium payments. Creating a captive enables the parent to reduce certain costs that are often added to the premium by a commercial insurer, allowing the parent to obtain the same coverage at a lower cost. These costs include trending, retention, insurance carrying, overhead, administrative fees, premium taxes, brokerage commissions, and miscellaneous fees.

Control of risk. Effective risk management allows a captive to control subsequent losses. Net retention 11 can be adjusted as market conditions change to achieve more cost-effective insurance coverage.

Cash flow. The commercial insurance industry has traditionally relied on investments as a primary source of income. While the captive insurance industry can take advantage of this principle as well, the investment income may be tax free to the captive, depending on where it is domiciled.

Access to reinsurance market. A captive may gain direct access to the international reinsurance market. Frequently, captives are able to obtain reinsurance to cover a particular risk that is less expensive than traditional insurance available in the commercial market.

Tax advantages are generally not the main goal in the formation of a captive, but some benefits may be available. For example, a U.S. company that is currently self-funding a layer of exposure for workers' compensation risks may choose to provide for this exposure through a captive. The company could then deduct the premiums paid to the captive, rather than deferring the deduction under the self-funding plan until the claims are actually paid.