What is a Captive?

Captive Insurance Company

A captive insurance company (captive) is a real insurance company created by a business or its owners to primarily provide property and casualty insurance  to affiliated businesses.  Because captives are usually owned by the same economic interests that own the operating business, the captive can be considered a “formal” method of self-insuring various risks.  Captives have been around for at least 70 years and have commonly been used by large businesses for decades.  Because the cost and regulatory burden of operating a captive  has declined considerably in recent years, smaller businesses can now benefit from them as well.   To legally sell insurance, captives must be licensed by the state in which they operate or another appropriate jurisdiction.

Typically captives are used to do one or more of the following:

  Insurance Risks that are presently insured via third party arrangement. By replacing insurance currently purchased from third parties with insurance purchased from your own insurance company, your captive can potentially realize profits currently captured by the big insurance carriers.
  Formally insuring risks presently self-insured via after-tax reserves. Most small businesses purchase third-party insurance to protect against only a small portion of the potential risks to which they are exposed, including those that are underinsured commercially. Most risks remain informally-self insured, (i.e. uninsured) because the cost of obtaining third-party insurance is simply too high given the business owner’s assessment of the likelihood of loss.
 Gain access to reinsurance markets. Ownership in a captive gives you access to reinsurance and excess insurance markets that aren’t available to the general public.
  Balancing coverage. Captives allow business owners the ability to actively manage their risks by balancing their commercial and self-insured exposures, and deciding which risks they’re willing to assume, and which ones they’d prefer to transfer over to a third-party carrier or reinsurance company.

How Does Your Business Manage its Risks?

A Blended Approach is Best

A blended approach includes commercial insurance, captive insurance and risk mitigation strategies

What is a CIC

Taxation of Captives

  • Traditional Captive Insurance Companies: Premium income is offset by reserves for losses (claims); the resulting Underwriting Profits (along with any investment earnings of the captive) are taxed at ordinary tax rates.
  • “Small” Captive Insurance Companies: Congress adopted section 831(b) of the Internal Revenue Code in 1986 to strengthen US small & mid-sized business. CICs electing to be taxed under section 831(b) are taxed at a 0% rate on underwriting profits, if premiums received are $2.2 million or less on an annual basis (adjusted for inflation). However, most investment earnings are taxed at ordinary rates.

Captive Insurance Timeline

  • 1956

    First Captive Formed

    First Captive formed by Youngstown Steel in Ohio.

  • 1977

    "Economic Family Doctrine" created

    “Economic Family Doctrine” created by IRS to limit captive benefits.

  • 1986

    Tax Reform Act passed

    Tax Reform Act of 1986 passed, encouraging the formation of “small” insurance companies under U.S.C. section 831(b).

  • 1989

    Brother-Sister captive structure allowed

    Brother-Sister captive structure allowed via ruling of Sixth Circuit court (Humana, Inc. v. Commissioner)

  • 1992

    Parent-Subsidiary structure allowed

    Parent-Subsidiary structure allowed via ruling of Ninth Circuit court (Harper Group v. Commissioner) – established 30% minimum for unrelated third party insurance insured by a captive (risk distribution)

  • 2001

    "Economic Family Doctrine" eliminated

    IRS Revenue Ruling 2001-31 eliminates “Economic Family Doctrine”

  • 2002

    "Safe Harbor" established

    IRS Revenue Ruling 2002-89 establishes “Safe Harbor” standard of 50% unrelated third party insurance insured by a captive (risk distribution)

  • 2002

    "Safe Harbor" expanded

    IRS Revenue Ruling 2002-90 expands risk distribution “Safe Harbor” to include 12 subsidiaries or related entities

  • 2015

    PATH Act increases limit

    PATH Act increases 831(b) limit to $2.2 million and indexes it to inflation in future years while placing some limits on estate transfer

Types of Captives

  • Single Parent (“Pure”) Captives – formed primarily to insure the risks of its parents or affiliates.
  • Association Captives – formed by a trade, industry or service organization to insure its members.
  • Group Captives – formed to insure the risks of multiple companies, related or unrelated.
  • Rent-a-Captive – formed to allow companies access to captive “benefits” who otherwise wouldn’t have access.
  • Protected Cell (AKA Segregated Cell or Series) Captives – allow for the segregation of assets and liabilities among different cells and their parent. Each cell must, individually, meet the definition of an insurance company.

* CIC Services is experienced in designing and implementing all types of captives.