About Captives
What is a captive insurance company?
A captive insurance company is a duly licensed insurance company, either domestic or foreign, that typically underwrites risks of the parent/owner. In many instances, a captive insurance company is a small insurance company when compared to traditional insurance companies such as AIG, Prudential or Metropolitan Insurance Company. Thus, a captive insurance company is generally not in the business to underwrite “public” insurance risks , such as the insurance companies above mentioned. However, when structured properly, captive insurance companies enjoy many of the same preferred tax benefits of most insurance companies. For that reason, many small captive insurance companies enjoy the benefits of the US Tax Code that permit small non-life insurance companies (less than $1.2 million in net written premiums) to pay taxes only on investment income. Of course, there are other tax benefits for owners of captive insurance companies who may benefit from preferred US tax rates on dividend income (currently at 15%.) Therefore, a captive insurance company is one method of alternative risk transfer using advantaged tax considerations, both individually and corporately.
What is a captive insurance company?
- Profits of the insurer are returned to investor/owners.
- Share in the gains of investment income.
- Be a part of selecting legal defense attorneys.
- Develop the type and form of insurance to be made available.
- Develop plan of shareholder distribution.
- Have input in the development of premium rates to be charged.
- Availability of worldwide reinsurance market.
- Tax benefits.
- Wealth planning and wealth distribution opportunities.
- Help lower insurance administrative expenses and commissions.
Where should a captive insurance company be formed?
A captive insurance company could be formed either onshore or offshore. The following places have been used in the captive formation process due to their competitive captive insurance laws:
Onshore Captive Domiciles:
- Vermont
- South Carolina
- Arizona
- Nevada
- Washington DC
Offshore Captive Domiciles
- Bermuda
- Cayman Islands
- Barbados
- Anguilla
- Nevis
- BVI
- Malta
Captive insurance companies are regulated companies that require special attention and preliminary planning before filing applications for approval by regulators. For example, a five-year financial pro forma is typically necessary in the application process. This pro forma study should include an income statement, balance sheet, projected claim losses and captive insurer expected expenses (administrative insurance management, domicile government fees, taxes and other potential claim expenses, legal and other claim defense costs.)
Each captive insurance company structure, nevertheless, depends upon the needs and plans of the parent/ owners.
- Onshore domicile or offshore domicile?
- Type of shareholder ownership?
- What risks to reinsure?
- Banking and investment considerations?
- Basis of capitalization?
- Business plan that includes legal/claims defense strategies?
Tax Benefits
Deductibility of premiums for clients. This means that clients of captive insurance deduct premiums paid to the captive insurance company as long as the captive qualifies. That means that the captive must be structured properly in order to obtain this benefit for clients. Generally speaking, this means there must be a clear transfer of risk to the captive and adequate risk distribution by the captive insurer.
Small captive insurers, those under $1.2 million in net premium revenues, may enjoy what is called “831(b)” tax benefits. That means the captive insurance company would only pay US corporate taxes on investment income. This tax benefit has been available for small US non-life insurers for many decades.
Investment gain (dividends) is currently taxed at 15% under long-term capital gains rates for US citizens. This favorable tax benefit is much lower than the current 35% personal tax rates for high income earners.
Onshore captive insurers have no need to file an election to be taxed as a
US corporation, however, offshore captive insurers typically file a 953(d) election
to be taxed as a US corporation. Thus, offshore captive insurers may elect to
be taxed and treated as a US corporation for tax purposes and file a 1120PC
annual tax return. This is important in order to avoid any excise or other such
taxes applicable to offshore corporations that do not elect to be treated as
a US corporation.
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