The explosive growth in lawsuits mean that many U.S. businesses find it difficult or impossible to obtain liability insurance at a reasonable price. Perhaps yours is one of them.
One solution to this problem is to form a "captive" insurance company. This is a company tailor-made to insure the risks of an operating business, or group of businesses.
The arrangement is "captive" because the insurance company is generally dedicated to the insurance needs of the business or group. Captives are also free to underwrite the risks of other related or unrelated businesses.
Premiums for a captive are usually lower than commercial coverage because there are no expenses related to marketing, sales, and agent commissions. In addition, premiums reflect the experience of a particular company or group of companies, rather than general market experience.
In a properly structured captive, it's also possible to deduct the premiums paid to a captive insurance company, and grow those funds tax-free.
Some of the top jurisdictions for captive insurance include Bermuda, the Cayman Islands, Guernsey, Luxembourg, Barbados, the British Virgin Islands, Ireland, and the Isle of Man. A number of U.S. states have also enacted captive legislation. Vermont is the leading U.S. captive jurisdiction.
Captive insurance also provides:
- Direct access to the reinsurance market, thus potentially providing coverage for risks not available through conventional insurance; e.g., nuclear risk, supertankers and labor stoppages;
- More effective claim management;
- Coverage more precisely tailored to a company's needs;
- Premiums paid the captive insurer are available for investment by the parent or associated companies;
- Increased investment options without restrictions by the U.S. Securities and Exchange Commission; and
- An independent profit center, if the captive acts as an insurer for other companies.
One problem with captives is that they're expensive to set up. It's not uncommon for a business to spend US$100,000 or more to create a captive arrangement.
However, you can reduce these costs by purchasing an interest in an already-formed captive in what's called a "protected cell company." These so-called "rent a captives" make it practical for businesses with annual insurance costs under US$100,000 to benefit from the captive concept.
Until recently, there was some doubt as to whether the rent-a-captive concept would provide the same tax benefits as a stand-alone arrangement. The IRS has now issued a set of proposed rules that stipulate when an arrangement with a cell of a protected cell company qualifies as "insurance" for federal tax purposes. This would make funds paid to the cell deductible as insurance premiums. These rules are welcomed since they provide a "road map" to tax practitioners as to how to proceed.
Setting up a captive insurance company is a major undertaking that you should pursue only with expert tax advice. There are many pitfalls for the unwary. The insurance arrangements must be bona fide and adequately shift and distribute risks.
Is captive insurance for you? If you or your business, or affiliated group of businesses, have an annual insurance bill exceeding US$100,000, the captive concept could result in significant benefits.
If you have questions about captive insurance, please don't hesitate to contact me at info@nestmann.com. My group works with expert attorneys who can set up captive arrangements for many types of businesses.
Copyright © 2008 by Mark Nestmann
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