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Are you interested in forming a captive insurance company to mitigate risk and increase profits? If so, you’re certainly not alone. Business owners are becoming more invested in captive insurance than ever before.
But what exactly is captive insurance?
A captive insurer is an insurance company that is completely owned and controlled by the insured holders within the company. This type of insurance company makes it possible to insure the risks of the company’s owners as well as provide underwriting benefits to the insured. A captive insurance company is usually a C Corp or LLC taxed as a C Corp.
A captive insurer is different from a mutual insurance company in that it is controlled by its policyholders, rather than just owned. Policyholders are often asked to participate in matters surrounding the insurance company. Essentially, insureds are putting their own capital at risk by essentially starting their own insurance firm to reach financing goals.
Captive insurance companies provide a unique form of coverage that isn’t available through more traditional forms, such as commercial property. In many situations, businesses will use captive insurance companies as a form of risk management or as one of several risk transfer concepts for their own financial security. A captive insurance company in many cases is best used as a supplement to already-established coverage.
So how does the structure of a captive insurance company work? Let’s find out.
Captive insurance structure may seem a bit complicated, but after this breakdown, we bet you’ll have an excellent understanding of it.
If you're a business owner and you've decided that a captive insurance company may work for you, the following logical questions would be, “What's the typical structure? How is it supposed to be owned?”
Let’s look at how a typical captive insurance company is structured to make sure it's compliant.
To start, let’s look at captive insurance law and the PATH Act. The IRS passed something called the PATH Act in 2015. The PATH Act states that the owner of the captive insurance company has to be the same as the owner of the underlying business with regard to spouses and lineal descendants. When it comes to captive insurance compliance and regulatory matters, it’s important to comply with this act.
So, in contrast to our typical captives today, you have a patriarch and matriarch that own the “cat” so to speak. They own the business. They create a captive insurance company that insures that business. Thus, they own the captive “prey.”
In the PATH Act days, there were structures where a patriarch and matriarch would own the business and they would have the captive insurance company owned by their children or a trust. Or, the patriarch would own the business and the matriarch would own the captive insurance company, thus getting money from one generation pass the estate and gift tax line.
The IRS didn't like that. So, they went to Congress and passed a law that said the owner of the business and the owner of the captive insurance company have to be the same with regard to spouses and lineal descendants.
Now, our typical structure today starts with the business owner. They own the business. They have employees. There is also the captive insurance company. The shareholders of the business are the same shareholders of the captive insurance company. They pay deductible premiums from their business over to their captive insurance company. They are also issuing policies to the business that insure the business, whether it's General Liability, worker's comp, or health insurance covering the employees.
Clearly, there's a lot of different policies business owners can write. But the typical structure nowadays is this: The business owner and the captive owners are one and the same.
Are you still a little bit lost? Understandable. Let’s take a look at some examples.
Let's say there are two or three business owners, and only one of those wants to start the captive company or wants to own the captive company. They can own different percentages. So if Owner #1 and Owner #2 are partners in the business, and Owner #1 wants the captive insurance company and Owner #2 doest, Owner #1 could own 100% of the captive insurance company (and either owner can be captive management partners) as long as they’re not a parent/child or a husband/wife.
How was our guide to structuring captive insurance companies? We want to hear your thoughts in the comments section. Don’t forget to subscribe to our blog for more captive insurance best practices!
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