Preface: A captive insurer is an insurance company where the insureds own the business. The owners underwrite insurance policies for their business or group, and place their capital at risk in anticipation of financial gains. For businesses or business group with captive insurance coverage, the business results in an investment company too. Captive insurance is a business, and requires comprehensive due diligence before any decisions should be made with the advice of a captive management firm.
What is a Captive Insurance Business
Some businesses subject to enterprise operating risks may choose to organize and fund a captive insurance corporation. A captive insurance business is simply an insurance company wholly owned and controlled by the insureds, e.g. Equipment Manufacturing, LLC can insure the risks on it’s manufactured trac-hoes with the formation of a captive insurance business.
Captive insurance businesses are distinguished from a mutual insurance business in that captives are not owned by policyholders. Captive insurance involves control of the company by the insureds, e.g. the Equipment Manufacturing, LLC president. In a captive insurance business, insureds put their money at risk with the insurance business completely independent from the commercial marketplace.
So a captive insurer is an insurance company. The owners underwrite insurance policies for their business or group, and place their capital at risk in anticipation of financial gains. For businesses or business group with captive insurance coverage, the business results in an investment company too.
Why would a business form a captive insurer? First, some businesses have risks that are not easily insurable, or premiums are high while claims are likely low, or maybe insurance is not available at all from the marketplace. Captive insurers provide broad coverage of businesses risks. Captive insurance business permit management of cash flow for and greater control on costs of the coverage, i.e. the greater capital accumulated from coverage revenues or investments, the more insulated the business becomes from changes in cash flow requirements for those risks.
Typically for every $10m in net premiums, a successful captive insurer can save up to $2m in operating expenses associated with marketplace insurance policies. So with numbers like that, captives are not for every business. But captive insurers can be group captives businesses with multiple owners, or industry captives, e.g. numerous businesses with common industry insure risk together.
Captive insurance companies were brought to the marketplace in the 1950 from Frederic M Reiss who designed them for a client with a business owning a series a captive subsidiary mines; hence the name captive insurance company.
Premiums paid to captive insurers are deductible for IRS tax purposes, like any policy. However the captive insurance company must have logic for the premium writing process of it policy, i.e. the underwriting.
IRC Section 831(b) contains the code for tax on insurance companies other than life insurance companies. Most common uses of captive insurers are in the middle market businesses, with insurance premiums of say $1m or greater per fiscal year.
For businesses interested in feasibility of captive insurers, captive management firms provide turn-key services from assessment, formation, and management of the underwriting, tax, and legal work.
This blog is not an endorsement of captive insurers. It is written to provide awareness of management of insurable risks in business and options available for affordable risk mitigation. If you have interest in captive insurance business, talk with your trusted advisor. Captive insurance is a business, and requires comprehensive due diligence before any decisions should be made with the advice of a captive management firm.