Every business must carry insurance coverage to protect it against risk. For example, businesses purchase workers’ compensation, commercial property and income loss insurance. However, some risks, such as product or pollution liability, may be expensive or difficult to insure. The company can either pay exorbitant insurance premiums, forgo coverage or start its own captive insurance company.
Captives give companies greater control over their risk. For example, they control the insurance underwriting and claims management processes. The captive’s investments can also be influenced by its parent company. These companies can fully customize their policies so they avoid paying for coverage they do not need while gaining coverage in key areas. They also control their deductibles.
Captives provide companies with access to the reinsurance markets. These markets may offer coverage at lower costs. Government programs, such as terrorism insurance, may also be open to those with captives.
In addition, the company controls the administrative and claims processes. Risk management is also more efficient because the company understands its own risk better than a commercial insurer. Market volatility does not typically impact the costs of captive insureds as they mature.
Captives can distribute their assets to their owners as dividends or long-term capital gains, reducing their tax burdens. Many captives are set up in tax havens, including the Cayman Islands or Bermuda, reducing the parent company’s tax burden. However, several states, such as Vermont, also offer captive creation benefits.
In addition, premiums are not considered taxable income. Although companies can increase their dividends by increasing their safety practices to reduce claims, if few claims are made or premiums are much higher than expected, the IRS may investigate the parent and captive company for tax evasion.
Captives offer effective risk management for otherwise difficult-to-insure risks. If your organization has this type of risk, consider investigating how to form a captive insurance company.