Captive Insurance For The Middle Market

By Philip E. Elworth

Every business self insures risk even though they have broad insurance policies in place. All insurance policies have a list of exclusions from coverage. If the exclusions are not covered under a separate insurance policy then you are at risk. In addition, there are many risks in your business that would be very expensive to purchase insurance for even if you could. These include credit risk, the inability to collect on your accounts receivable or the creditworthiness of your key customers or suppliers. Certain product liability items are often not covered as well as product or equipment obsolescence or changing market conditions. Are any of these risks potentially less catastrophic if they occur, than say a fire?

There is a vehicle available that can help business owners cover these risks tax free as well as provide a mechanism for potential estate tax planning, key man retention as well as the safety of having cash assets beyond the reach of creditors. This vehicle, in its many forms, is called a captive insurance program. This product has been around for over 100 years but has not been readily available to the middle market until the past decade. Basically, a captive insurance plan is your own private insurance company but the only company that can file a claim against it is your own. Premiums accumulate over time and if there are no claims then the cash is yours with more favorable tax treatment then the original premium cost would have allowed for. You have the ability to transfer up to $1.2 million in premium cost into the captive each year. This premium is a deduction on the insured’s books and is not taxable income under the captive.

In order to qualify for a captive, the business should have at least two of the following; taxable income greater than $1.5 million; uninsured risks of $250,000 or more; 100 employees or more; or actual premium costs of $500,000 or greater. The reason for the requirements is the captive insurance program will cost $40-80,000 to set up and $18-40,000 per year to maintain. All of this should be more than covered by the tax savings in the first year to make it worthwhile. Since this cash will leave the business, the premium dollars must not be necessary for ongoing operations for the program to be effective.

Captive insurance plans are complex and should not be entered into lightly, but can be a very effective means of managing risk and ultimately potential vehicles for estate planning, wealth transfer or business exit strategies.