On Looking After the Business: The Basics of Captive Insurance

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A lot of unexpected things happen in the course of life. On account of this, many people purchase insurance plans to cover them financially in the event of an accident, sudden illness, or untoward natural occurrences. Even corporations aim to mitigate risks by investing in insurance companies. However, not all businesses are financially covered by traditional insurance companies in the market.

What can these businesses do, then? They can purchase self-insurance, in which they set aside money to cover a possible loss. With self-insurance, the insured party pays for medical procedures, property damage, or theft with their own money under their own policy.

One type of self-insurance is captive insurance, a subsidiary risk-mitigation company that is entirely owned by a parent company. Companies that cannot find an insurance provider to cover their business risks can opt to form a captive insurance company as an alternative risk management service provider.

Per cantleydietrich.com, “The taxation and insurance law issues related to captive compliance are complex and ever-evolving.” Setting up captive insurance companies also necessitate additional overhead costs such as personnel and office equipment. As a result, large corporations typically comprise the captive insurance market.

The Two Types of Captive Insurance

Captive insurance is are divided into two types: pure captive insurance and sponsored captive insurance.

Pure captive insurance companies can have one owner (single-parent captive) or multiple owners (group captive).

In a single-parent captive, the sole owner provides capital and pays for the premiums. One of its key advantages is that the sole insured has the ability to control investments. On the other hand, a group captive is operated by multiple captive members who can benefit from collective purchasing power. With a group captive setup, members can better control risk and pay lower premiums.

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Group captives are further divided into two groups: industrial insured group-owned captive and heterogeneous group captive. The former is owned by captive members within the same industry or with the same business risks, whereas the latter is formed by captive members from different industries.

The second type, the sponsored captive insurance company, is one that is owned and controlled by a third party which is not in any way related to the insured parties. Unlike in pure captive, sponsored captive does not require members to pay a capital risk. Instead, the company only requires an access fee.

In this structure, members can choose if they will share risks with other members. Meaning, if they choose to share, the premium paid by members covers other insured parties. Otherwise, the premium only covers the risk of the contributing member.

Captive Insurance Company and the IRS

All insurance companies – traditional or alternative – are regulated and governed by the Internal Revenue Service.

One such law concerning captive insurance companies is the 831(b) of the IRS Code. In essence, 831(b) mandates captive insurance companies to disclose the following:

  • Information about the company’s transactions
  • Name and contact of underwriters
  • Explanation on how the amount of premium was determined
  • Description of the company’s assets

Any time a company or an entrepreneur decides to form a captive insurance company, they should consult with a lawyer. Doing so allows them to know if they are operating within the boundaries of the law.

Insurance companies can, at times, be strict when it comes to claims. For this reason, if an insurance company refuses to cover possible business risks, it’s time for the owner to consider protecting their investment with an alternative risk-mitigation company: captive insurance.