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Most Common Captive FAQs

These are some of the most common questions asked about captive insurance companies. If you have specific questions, please do not hesitate to contact usCaptives are no longer just for the Fortune 500 who have long understood the benefits of owning an insurance company.

Wide Application of Captives Today

Historically captives were thought to only make sense for companies with at least $100,000 in traditional insurance premiums and over $10,000,000 in revenue and at least 50 employees. Due to legal innovations and declining capital requirements and operating costs, this is no longer true. Some group, cell and series llc captive programs make financial sense for much smaller companies and professional practices. These smaller captives often take advantage of US Internal Revenue Code section 831 B which allows qualified small captive insurance companies to be exempt from federal income tax on operating income. 

Frequently Asked Questions

Q: What is a captive?

 Captives are formalized self insurance created by forming a new entity that applies for admittance as an insurance company by a US state (more than 30 now have captive authorizing statutes) or by an offshore domicile that regulates insurance companies. Most commonly captives are formed by a related parent company, professional association or group to insure the risks and exposures of the parent (and affiliates), association or group rather than buy traditional commercial insurance to fund all risks. Captives are usually a good choice for a company with a good loss record, good risk management and the ability to finance its own exposures. Captives are mature risk transfer and finance vehicles utilized throughout the world. They are part of the insurance industry landscape known as "Alternative Risk Transfer” or “Alternative Risk Finance.” 

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Q: Why form a captive?

Our "Captive Background" information is helpful to put captives "in context" and remove much of their mystery. Captives are attractive if you pay large insurance premiums yet have a good claims and loss history or if you need an efficient method to finance other types of risk. Captive insurance program participation is popular in the medical, manufacturing, construction, distribution, hospitality, professional services and commercial real estate industries yet has much wider application.

Captive insurance programs allows you to retain an interest in premiums and earnings on premiums. They give you more control over the claims process too. With a captive you have an ownership interest in the insurance company you pay premiums to. Structured and managed correctly, captive insurance company participation can be a very good investment and make you more competitive. Captives are now more affordable to participate in than ever before due to recent innovations. They are no longer only for large companies, groups or associations.

Captive insurance company's can reduce risk financing costs over buying general marketplace commercial insurance policies.  They increase predictability of costs too. Captives are better than self-insuring in many cases. Captives more efficiently cover self-insured retention and are tax favored methods of building reserves. Captives can cover specialized risks that are unique and have no commercially available coverage. Captives can provide a creative cost effective method to address risks above existing insurance policy limits, not just insure layers of retention on the lower end.  

Remember, insurance companies are in business to make money; Lots of it if they can. So if you are a large purchaser of insurance or self-insure substantial risks, you could save money owning your own captive insurance company and create a new profit center leveraging your industry expertise.

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Q: Who Benefits by Formation of a Captive?

 The "winners" associated with captives are numerous: Traditional insurers have typically viewed themselves as the "losers" (of market share) when business that has been commercially insured creates or participates in a captive. A number of commercial insurers have continued relationships by participating in the captive as reinsurers, as fronting insurers, or as sponsors of captive programs. Many large commercial insurance brokerages have found captive programs the ideal way to increase client service levels and retain clients over very long periods of time. Sophisticated commercial brokers in recent years are embracing captives in a major way. This underlies the growth in captives globally despite a soft insurance market during the troubled economic environment of recent years. 

Insureds are the beneficiaries of underwriting profit and investment income. Insureds also are winners if they design tax favored risk coverage through their captive not available in the commercial marketplace. Insureds are also winners if the captive achieves larger planning objectives.

Reinsurers have new opportunities to partner with captives and expand the reinsurers' products or clients. 

A large service provider network has emerged in the captive arena: 

Attorneys: Specializing in the legal aspects captive formation and captive taxation. 

Captive Managers: Usually located in the domicile where the captive is licensed, captive managers are responsible for regulatory compliance and keeping the captives' books. Typically, captive management firms are independently owned or are part of a larger organization such as a financial services company, insurer, or broker.

Auditors: Captives are required to have annual audited financial statements. The audit firms they use may be the "Big Five" or regional firms with captive experience.

Actuaries: Captives require annual actuarial loss evaluations. Many captives rely on opinions from well-known national and international firms; however, some use small independent firms.

Agents and brokers: Captives have served as a tool for agents and brokers to use in successfully developing niche markets. In addition, some national brokers and regional independent agencies have created captives in which they share ownership and profits with their client- insureds.

Asset Managers: Investment advisers with captive expertise have found captives to be good clients as a well run and designed captive can build substantial investment assets for its owners.

Other constituencies that benefit from the development of the captive sector include consultants that give advice on such ventures, third party administrators, and loss control providers that supply some of the unbundled services to captives.

Q: What are the different types of captives?

The most common types are pure or single parent captives; agency captives; industry group captives; association captives; risk retention group captives; rent-a-captives; segregated and protected cell captives (Series LLCs are included here); and special purpose reinsurance vehicles.

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Q: Which domiciles are best?

Making the best domicile selection is challenging. It requires analysis and familiarity with each domicile's nuances. Most advisors are familiar with only a handful of domicile options. Important consideration must be given to costs, however costs are merely the starting point and one piece of the puzzle.

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Q: What are the tax implications?

Government taxing authorities worldwide recognize the special nature of insurance contract arrangements and the importance of encouraging savings to address unusual loss risks. Accordingly special beneficial tax rules have evolved that apply only to insurance companies. They enable you to defer, reduce and in some cases eliminate taxes otherwise applicable to non-insurance companies.

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Q: What are the costs and risks associated with a captive?

Forming any new business involves costs and risks. The pros and cons need to be carefully considered. Captive insurance companies require specialized skills to form and manage. Most hire and rely on outside professional service firms. Assuming good management, the greatest risk is experiencing claim losses and related claim management expenses greater than anticipated. While it is easy and often necessary to spend considerably more, smaller pure captive programs can be implemented with under a $50,000 start-up budget, and operated with as little as $30,000 in annual fixed overhead expenses.  Some protected/segregated cell captive and series LLC captive programs can be initiated and maintained much less expensively today. Most smaller service providers lack the resources, expertise and experience to efficiently and competently manage sophisticated segregated and protected cell or series LLC captives competently despite marketing them aggressively.  There is wide industry concern the lowest cost providers may be selling 831 B programs that will not hold up on audit due to poor program design and documentation.

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Q: What are the steps involved with forming a captive?

To assure long-term success, begin the process by completing a feasibility study. If done by an industry expert, it will lay out in some detail the exact steps to follow to implement a captive insurance program and provide operating financial projections. An independent feasibility study or independent review of your selected captive manager or actuary study is encouraged and can be completed for as little as $5,000.

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Q: Is a feasibility study necessary?

There are always exceptions to every rule, but we believe a feasibility study in one form or another is an essential first step whether your chosen domicile requires it or not … feasibility studies can be done in stages rather than committing to a comprehensive expensive feasibility study all at once. The first stage would be engaging a consultant to do at least a preliminary analysis to confirm spending money on a full blown feasibility analysis seems warranted.

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Q: What kind of risks can be underwritten?

Any type of definable and reasonably measured risk that can be protected against with insurance can be covered by a captive as well. Risks not coverable by commercial insurance can also be financed through a captive. Click here for examples of the many types of risks captives can address. One of the main benefits of a captive is custom tailoring insurance policies to cover your specific risks in ways not available in the general commercial insurance marketplace. And to cover risks where there is no commercial insurance available. Examples might include flood insurance in your area, other acts of God, or even protection from terrorism and acts of war. Smaller 831 B captives, especially cells or series SBUs of existing programs, are often limited to writing enterprise risks of a catastrophic nature due to the small amounts of capital often required of these 831 B programs.

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Q: What’s involved in managing a captive? 

Managing a captive involves a wide range of activity that varies to some degree from captive to captive. Some of the duties and responsibilities are common to any business. Others require specialized knowledge and professional skills. Fortunately experienced experts are available who offer contract management services so you can run a captive business literally without any employees if your current staff does not have the time or expertise. Determining what scope of services you will need, and how best and most cost effectively to harness the resources needed, should be part of any quality comprehensive feasibility study.

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Q: How can a captive be used for asset protection and

estate planning?

Sometimes, but not always, asset protection and estate planning objectives are part of the business goals and objectives of a captive insurance company. Due to the complexity of these areas, nd the fact that they cross over into specialized legal and tax advisory areas, not to mention the confidential nature of our multi-jurisdictional expertise gained over the years as veterans in this industry, we prefer to discuss these matters only under confidential circumstances with your legal and tax counsel. If you do not have qualified legal and tax counsel, we can help refer you to appropriate experts.

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Understand captive insurance industry terms by clicking here to review a glossary of most common terms used.

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