What type of businesses could benefit from a captive insurance company (“CIC”)?
- Businesses that are overpaying for third party insurance or with significant uninsured or underinsured risks
Examples: Contractors, developers, medical groups, family owned businesses, physicians, entertainers, professional athletes, high tech firms, professional service firms, real estate management companies, etc. Upon reflection, almost every business has significant uninsured or underinsured risks.
- Businesses with sufficient revenue and profits to afford the premium
- – Over $1,000,000 in gross revenue.
- – Over $200,000 in “excess” after-tax profits (i.e., money that doesn’t need to be directly reinvested into the business or paid out as compensation).
Tax savings versus informal self-insurance arrangements
Assuming that your captive insurance company (“CIC”) is a proper, licensed insurance company that writes appropriate, relevant insurance policies in exchange for independently-priced or market comparable premiums, then premiums paid to your CIC should be deductible to your business just as if they were paid to a third party insurer. For instance, if you paid $1 million in premiums to your CIC this year for valid insurance, the resulting deduction would save you or your business $400,000 in taxes if you’re in a forty percent combined federal and state tax bracket.
In addition captive insurance companies receiving less than $1.2 million per year in premium income, can elect to have their underwriting profits taxed in a zero percent bracket under Code Section 831(b). For example a CIC which takes in premiums of less than $1.2 million per year with its premium income exceeding claims paid, may have those profits taxed in a zero percent bracket. Assuming $1 million of CIC premiums and a forty percent tax bracket that represents $400,000/year of potential tax savings by formally self-insuring risks through a captive versus not insuring these risks at all as most businesses do.
Why do captives enjoy such a low tax bracket on underwriting profits? Some hypothesize that Congress may have decided that third-party insurance arrangements should not be favored by the tax code over formal self-insurance arrangement like CICs. Also, it seems that Congress may have intended to incentivize small businesses to begin setting aside reserves to insure risks they have failed to cover via third parties due to cost, lack of available coverages for certain risks, or other considerations. Section 831(b) incentivizes small businesses to responsibly reserve for these risks through captive insurance arrangements.
Despite the obvious and frequently-noted tax advantages of a CIC, no business transaction should ever be completed simply or even primarily to achieve tax savings. In some cases the IRS has authority to deny deductions that result from primarily tax-motivated transactions. Thus, the decision to implement a CIC should be based upon the business owner’s careful considerations of the risks facing his/her business and the various means of mitigating them, and his/her decision-making process should be documented. Unfortunately, it’s the rare business indeed that doesn’t have considerable exposure to innumerable uninsured risks, potentially bankrupting the business if left unaddressed, and which self-insuring via a captive can mitigate. Your captive attorney and his or her insurance manager can assist you in recognizing and developing a plan to protect against such risks.
Why form a Captive Insurance Company (CIC)?
- Reduce Insurance Costs: Conventional third party insurance policies insure a bundle of risks that may not be particularly relevant to you. A standard package may include both relevant and comparatively irrelevant risks, and yet you pay for both. In other words, you may be paying for coverage that you don’t need while “going naked” on coverage that you do. Third party insurance premiums also include markups for things like marketing expenses and large underwriting departments, which may not benefit you at all. These additional costs are reduced or eliminated with captive insurance.
- Protect Your Business From Risk: The attorneys and insurance managers who assist you in forming your CIC are experts at identifying relevant but often over-looked risks. Because CICs offer the ability to obtain tailor made insurance, your business should be better prepared to survive the unexpected
- Improve Cash Flow: The potential savings realized by obtaining cheaper and more relevant types of insurance, combined with the tax savings that CIC’s provide, may result in significant improvements in your business’s after-tax cash flow. There is also a decided advantage in being able to time the premium payments to the company’s natural cycle of cash flow.
- Create Profit Center: Studies show that businesses which own a captive better manage their risk than 3rd party insurance companies, allowing CIC’s to have a much lower loss ratio. Captives are often therefore highly profitable. These profits can be invested in ways that which generate valuable investment income. The result is often a new profit center for your business enterprises.
- Increase Asset Protection: Properly formed and maintained, the profits of a captive are very well insulated from the creditors of both the business and the business owners.
- Estate Planning: If your captive is owned by your children or a trust for the benefit of your children, then premiums paid to the captive each year are effectively removed from your taxable estate without gift taxes.
My Professional CFO, LLC, is a Business Management firm providing the highest level of service in three key areas of importance to Independent Contractor Physicians, Attorneys and Information Technology Professionals. We specialize in Corporation and LLC filings and ongoing Compliance, Accounting and Payroll, and Investment Management. Our professionals will assist you in forming the appropriate type of company for your situation and work with you to make sure your company remains compliant. We provide ongoing Accounting and Payroll services to make certain all bills are paid and necessary tax forms and withholding payments are made in a timely manner, as well as the set up and management of your retirement accounts. We are not simply a document filing service, we are here to help you with the part of the business that you have to do, so you can focus on what you love to do. For more information visit our website www.myprofessionalcfo.com Alan Conner, MBA – President of My Professional CFO, LLC has nearly 2 decades of experience working with professionals and small business during both the start-up and ongoing management. He has written countless business plans and has managed assets for both institutions and high net worth clients. Email us with any questions. Call us at: 1 (800) 517-0CFO 1 (800) 517-0236 Captive services powered by: