Over the last several years there has been significant growth in the utilization of captive insurance companies. There are several types of captives including pure or single-parent captives, group captives and other structures, including association captives, segregated cell captives and risk retention groups. A pure captive can be either a large or a small captive. Small captives are sometimes also referred to as micro captives.
A small captive can offer unique tax planning opportunities because an eligible small captive can elect to be taxed under the provisions of Internal Revenue Code section 831(b). Under this Code section, if the net written premiums (or, if greater, the direct written premiums) do not exceed $1.2 million, the insurance company is taxed only on its taxable investment income, which is taxed at corporate rates. However, a net operating loss generated by the company cannot offset investment income and cannot be carried to or from any tax year for which the company has an election under 831(b). The beauty of this arrangement is that the parent operating company (the insured) still gets to deduct the insurance premiums paid to the captive, while the captive gets to exclude the premium income from tax, as long as the premiums are under $1.2 million.
A captive insurance company is still an operating insurance company which will make payments to the entities it insures as covered losses are incurred. Over time most insurance companies succeed at having the premiums received exceed covered losses incurred and therefore the insurance company accumulates surplus which can also be invested. The build-up of surplus typically means that the captive is increasing in value and this anticipated outcome also means that an opportunity can exist for estate planning, preferably at the time the ownership structure of the captive is established. Professionals well-versed in estate planning and captive insurance taxation should be engaged to advise related to these opportunities.
A captive should not be viewed purely as a tax planning vehicle. Although tax savings are available, the captive is first and foremost in the insurance business. Insurance companies are subject to the rules and regulations of their domicile as well as potentially subject to scrutiny by the Internal Revenue Service to verify that the captive is providing legitimate insurance with appropriate risk shifting and risk distribution. Yet, if the captive is properly structured and appropriately run as an insurance business, potential tax savings can increase the value of utilizing a captive insurance company.
For more information on Captive Insurance Companies, please contact Tom Jollay or call 770.396.2200.