Captive Insurance Basics
What are the unique benefits of forming a captive insurance company
- Customized coverage specific to your business and specific risks versus a one size fits all approach.
- Greater control over underwriting and claims management
- Avoid the volatility of the cyclical insurance market.
- Access to reinsurance markets
- Strengthen the ability of your business to survive by planning for and protecting against foreseeable risks.
- Capturing lost underwriting profits
- Generate additional investment return on premium and reserve assets.
If certain requirements are met, such companies may elect to pay an alternative tax based only on taxable investment income, making underwriting profits exempt from federal income tax.
What is Internal Revenue Code Section 831(b)?
Section 831(b) of the Internal Revenue Code allows small captives to make a tax election so that the premium they receive is not taxed as income to the captive. The captive will be taxed on interest and investment income earned. The purpose of this special tax election is to incentivize smaller mid-market companies to provide insurance coverages in a more capital efficient manner than purchasing on the commercial market. The result is a stronger business enterprise with enhanced growth potential.
IRS Code Section 831(b) Requirements:
- Company must be a non-life insurance company
- Net written premiums must not exceed $2.3 million
- It must make the election to be taxed under section 831(b).
- Transactions must meet a four-part test for the presence of an insurable risk, shifting the risk to the insurance company, distributing the risk and formal recognition of the transaction as insurance.
What are the legitimate business reasons for establishing a captive insurance company?
- To obtain coverage where insurers are unwilling to do so
- To reduce premium payments
- To control risk
- To increase cash-flow
- To gain access to re-insurance market
- To create diversification
- To balance coverage
How Captive Insurance Has Evolved
Youngstown Steel forms what later became known as the first captive insurance company.
Congress inserts a provision into Sec. 831 to open up a significant planning opportunity for small insurance companies. Provision is known as Sec. 831 (b)
IRS starts to formulate “safe harbor” rules and clarify essential elements necessary to qualify as an insurance company.
Congress changes the requirements for qualification and increased the premium limitation amount
Captives in existence
Of Fortune 1000 companies have captives.
Of all property and casualty premiums come from captives
U.S. states provide domicile/numerous international domiciles