Privately-Held Insurance Company

A privately-held insurance company, also known as a captive insurance company or “captive”, is an insurance company primarily formed to help underwrite the risks of a parent organization or related entities.  The planning opportunities abound since a captive can be owned not only by a business owner, but also by a trust, spouse, or children of such business owner or any other company the business owner may own.

Today, there are more than 5,000 captives worldwide.  It is estimated that there is over $20 billion written annually in premiums to these captives with surpluses estimated at more than $50 billion.

Captives can be formed either in the United States or in foreign jurisdictions.  Currently, there are approximately twenty-four (24) states and more than thirty-five (35) countries that have legislation supporting captive insurance.  The basic differences between the jurisdictions are flexibility of entity and costs of ownership.  However, in recent years, some U.S. states have developed regimes which compete with the most frugal foreign jurisdictions.  This has resulted in a greater number of captives being formed domestically and has drawn the attention of business owners who are more comfortable doing business with and operating domestic entities.

One of the primary reasons for the increased attention to creating captives has been the lack of certain types of insurance coverage in the current commercial market.  In addition, a captive may be formed to reduce the cost of purchasing insurance through the commercial markets, because as much as 35-40% of premium represents the acquisition costs, overhead, and profit of an insurance company.  If an individual forms a captive, these profits can be retained by the individual.

Another reason to form a captive is the existence of a large gap in the commercial market for certain coverage.  In many cases, the commercial market has been unable or unwilling to provide coverage for certain types of risks, or the prices quoted are unreasonable.  A captive not only can fill this gap, but can create additional profits for the owner.  These profits and cash flow can be used to create investment income within the captive.  These and many other reasons drive individual businesses to create their own captive insurance companies for their specific risk management profile.

In considering the use of the captive, one must review and understand the various solutions that can be designed to meet the specific needs of the business owner.  Considering the nature of the business operations, the existing coverage, the various unique risks that the business can be subject to, and the ability to identify the underinsured risks, allows management to put themselves in a better position to consider utilizing a captive to reduce some of the business risks that may not be insured or may be too costly to insure.

The business owner forming an insurance company, which in essence has a captive customer (i.e., the business and its risks), can then benefit from the numerous income and estate tax incentives in addition to reducing the business owner’s costs and covering risks that may not have been covered in the commercial market.

An insurance company that earns less than $1.2 million of net-written premiums each year will be able to accumulate premiums in a very favorable tax environment.  In addition, those assets being held within the insurance company will also provide asset protection to the business owner.  Depending on how the insurance company is owned, a captive may also provide estate planning and wealth transfer opportunities for the business owner’s family.  These are all ancillary benefits that in many cases prove to be worth the effort of exploring whether a captive makes sense or not.

There are several types of captive insurance companies.  The most common are:

  • Single Parent Captive – A reinsurance or insurance company primarily formed for insuring the risks of its non-insurance parents or affiliates.
  • Cell or Series Captive – This particular captive provides insurance facilities to others for a fee, and at the same time is able to protect itself from losses under individual programs.  Losses to one cell or series are further isolated from losses under other programs within the same company.  The use of this type of captive is most efficient for companies that wish to take advantage of available tax incentives and achieve asset protection goals.
  • Group Captive – These companies are formed by a number of companies all for the specific purpose of providing a vehicle to meet a common insurance need.

There are many advantages to considering a captive for an entrepreneur’s business insurance risk needs.  In addition to managing risks and capturing insurance profits on a favorable tax basis, captives may be utilized for wealth transfer and to achieve sophisticated estate planning objectives.