Launching a captive insurance company allows the owner of multiple small businesses and commercial properties to close gaps in coverage while saving millions in taxes and retaining investment profits to fund those potential losses. Find out how CRI helped this owner evaluate his options and get this new venture started on the right foot.

Client: Owner of multiple companies in several different industries and multiple commercial rental properties

Challenge: Fund uninsured or underinsured business risk

Solution: 831(b) captive insurance company

Results: Tax-advantaged treatment of captive company enables client’s businesses to fund previously uninsured or underinsured risks while netting more than $2 million in three-year savings that can be used to fund losses
As the client’s enterprise grew, his businesses were taking on risks that were either insufficiently insured due to high deductibles or uninsured because coverage was either unavailable or prohibitively expensive. While the risks of these losses were low, the potential business impact would be severe.

Cybersecurity: A data breach could cause significant financial and reputational harm to the client, who handles protected health insurance information and other private data on behalf of its clients and their beneficiaries. Commercial cyber insurance was impractical due to high premiums and excessive exclusions.

Loss of key contract: Another significant risk, for which third-party coverage was not financially feasible, involved the potential loss of a key contract that represented the majority of income for one of the businesses.

Worker’s compensation, general liability, and commercial auto deductibles: Deductibles for each line were inching up into the $100,000 range.

The client needed to close those coverage gaps, and self-funding was proving increasingly impractical with income taxes depleting available funds. (Note: his businesses are taxed at an average combined rate of 45%). Rather than pay these funds to Federal and state treasuries, the client sought a way to build up his loss fund. The client turned to his longtime accounting advisors at CRI for assistance. After reviewing his situation, we recommended looking at the benefits of a small captive insurance company (“captive”).

A captive is an insurance company created and owned by a parent company that pays tax-deductible premiums to build up the loss fund. A “small” captive is one that writes less than $2.2 million in annual premiums (as of 2017) and qualifies for significant tax benefits, including:

• being taxed on investment income only, and
• having distributions taxed at dividend rates (currently 20%) rather than ordinary rates.

The net result of these tax benefits is that captive insurance companies typically retain underwriting profits, allowing capital to grow into a comfortable cushion with which to insure future losses.

The study also identified risks that were self-insured, as well as where it was advantageous for the client to assume a larger deductible for commercial policies and insure that “layer” of coverage within the captive. Identified risks included:

After vetting the idea, CRI introduced the client to an experienced and knowledgeable captive manager, actuary, and attorney to get the captive started on the right foot. First, the captive manager performed a feasibility study to identify uninsured or underinsured risks that were appropriate for the captive, such as:

Next, a licensed actuary determined premiums for each line based on underwriting and rating guidelines plus best practices in the insurance industry. Premiums will start at $1.15 million for 2017. Added lines of coverage will increase those premiums to $1.9 million in 2018 and $2 million in 2019.

The attorney and captive manager drafted policies based on the identified business risks and premiums. Then, they filed the application with the state and obtained an insurance license for the captive, which begins operations in 2017.

Thanks to careful planning and set-up, the captive insurance company will cover losses that were insufficiently insured or uninsured while bestowing the following significant tax benefits on the client and his companies:
  • Any premiums paid to the captive are tax-deductible to the businesses.
  • The captive is taxed on investment income only.
  • Distributions to shareholders of the captive will qualify as dividends and be taxed at the Federal rate of 20%.
The client can now take comfort in knowing that these types of unexpected losses will not throw his businesses off track.
If you are ready to explore the risk management and tax advantages of a captive insurance company, then CRI is here to guide you. Contact us today!

The following factors led our team to determine that a captive insurance company was a good fit for this client’s situation:

Sustained profits. With administrative fees that start around $70,000, a captive insurance company is generally feasible for companies with a net income of at least $1 million.

Sufficient premiums. Ideally, captive insurance companies have at least $500,000 in annual premiums.

The right motivation. Given the tax advantages of captive insurance companies, the IRS scrutinizes these structures closely. The client was approaching the decision with the right business motivation: a desire to shift risks in a financially prudent way.

Expected growth. Captive insurance companies typically work well in businesses that expect to grow within the next few years.

Large number of employees. In many cases, captives work well for putting some existing employee benefits insurance coverages in the captive.