What You Need to Know About Captive Insurance

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Medical Expense Stop Loss insurance is a smart and economical way to lower costs and improve employee health insurance. Currently available only for employers with 50 or more insured employees.

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  • 1. About Captive InsuranceCaptive Insurance is an investment in ones self and ones business. Well applied it can reduce the net costs ofinsurance/risk management by 20% or more and create real income from funds that would otherwise haveevaporated into the ethers of taxation and bureaucracyCaptives are just closely held, privately owned insurance companies. But they are licensed by governmentalauthorities and, to be worth a hoot, they must be viewed by the IRS as Real insurance companies. Very broadlyand succinctly defined, a Real (Captive) insurance company is one whose owner is insuring at least 12 taxpayingentities that he or she controls, or, alternatively, one which develops more than half of its premium incomefrom outside interests. In most cases the outside interests are other insurers and reinsurers seeking to spreadrisk.Formation and management of most Captives is done by professional Captive management companies. Theywill design an insurance company to fit your needs and generally charge at least $40,000 and more likely closerto $75,000 for their service. Next, you will need to Capitalize your insurance company with a sumapproximating 25% to 33% of the annual premium that is projected in your Captives business plan. For theclass of small Captives known as 831(b) companies the Capitalization will be between $100,000 and $400,000.Ongoing annual management expenses for 831(b) companies will range from about $35,000 to $50,000 ormore.The charms of Captives are numerous and diverse. Basically they free their owners from a variety of annoyingheadaches caused by the skittish or imperious behavior of commercial insurers, and they usually result in acomfortable return on investment. Their financial virtue results from a) having direct access to reinsurers andb) from the privileged position that US tax policy offers to insurers. A Captive insurer that accrues less than$1,200,000 per year in premium can elect to do an IRC 831(b) filing and pay no federal income tax onunderwriting income. Larger Captives generally increase their reserves against future loss each year and deductthose increases as non-taxable.Captives are not for everyone, but there are at least several hundred thousand successful professionals, small-medium and medium sized businesses in the USA who would benefit by owning one. As Kipling put it, for thestrength of the pack is the wolf, and the strength of the wolf is the pack. When a Captive comports itself fairlyand wisely, it can team up with others of its sort and that pack can become a power in the jungle. Who Nearly anyone with the will and the means can own a Captive. So, perhaps the better question isWho should consider becoming a Captive owner? We begin with the means test: Does your business or profession require annual insurance expenditures of more than $500,000? Does your business generate annual income of more than $1,000,000? Are you or your business threatened by an above average likelihood of a major liability lawsuit? Do you offer a product or service of such high value that your customers may want to insure it?
  • 2. A positive answer to any of the above and many similar questions would suggest that one should at leastconsider the potential of a Captive.Captives tend to draw the attention of the IRS, so if you form one, do it right. Ownership of an insurancecompany puts you in a very special tax situation. Captives are bona fide insurance companies. Premiumspaid into them are tax deductible. In newly formed insurance companies, all or nearly all premium in excessof operating expense and claims expense is added to the companys reserve accounts. As the companymatures, its actuarial staff usually continues to advise that reserves should be increased to prepare forfuture loss. Additions to reserves are tax deductible.For wealthy people, a Captive owned by a well designed trust can significantly increase what is passed on totheir heirs.Other wealthy people, particularly those whose assets may come under attack from litigants or otherparties will find that Captives designed with asset protection as a goal serve their purpose well.Comments? Please address them to comments@CaptiveInsurance.info WHYThe real beauty of Captive Insurance Companies is that they bring to hundreds of thousands of businessowners direct access to the reinsurance marketplace plus the ability to systematically set aside reservesagainst future fortuitous loss and to do so on a tax deductible basis. Captives allow their owners theprivileges that have enabled so many insurance companies to become financial giants. Captives havechanged the game.You already self insure. You have conditions and exclusions in your commercial insurance policies thatconstrict your ability to recover losses. You are confronted by a legal climate that seems to create a need fora new kind of liability insurance as quickly as you can recover from the last one. You want to be safe but youcannot afford to cover yourself against newly emerging risks of loss, especially when someone else is layingdown the rules about whats covered and whats not, or what you must have to compete for business.With your own Captive you can set aside reserves to protect yourself against loss from any and allreasonable risks of fortuitous loss. When there is a claim against you it is settled by a third partyadministrator who is paid by you to settle it. You gain latitude to influence the payment of claims. At theend of the policy year, the difference between the sums of premiums paid in and claims paid out or held inreserve is your underwriting profit. In growing companies all or nearly all of your underwriting profit ismoved into reserve accounts in consideration of the probability of future loss.Like any other insurance company you are in business to make a profit, hopefully a big one. If you had beenself insured without a Captive, you would have paid your claims and they would have been taxdeductions. But because you thought ahead you have increased the reserves and the value of your
  • 3. Captive insurance company instead. Money that would otherwise have been taken by your governmentas taxation has been converted to wealth.Some Financial Advisors and accountants look down their noses and shake their heads at the thought ofadvising their clients to take advantage of Captives as an opportunity. Their caution is well advised becausemany a Captive owner has been the victim of misinformation or mismanagement. Whenever, wherever taxdeductions are involved, the IRS is watching closely.If you engage a Captive Insurance Manager, make your choice a good one. As with every other business orprofession, 50% are below average. Seek out a Captive manager who is in the top 10% of his or herclass. They may cost you a little more up front but they will earn your respect and gratitude. For Questions, Comments or Further Explanation, call CaptiveInsurance.info at 1-760-366-4670