Reduce costs and realize tax benefits through a captive insurance program

A “captive” is an insurance company that has some common ownership or management with each of its insured companies, meaning that it only insures the risks of its affiliated companies. Its specific form is dictated by the risks, needs and goals of the companies that it insures.

“Captive programs enable companies to take control of their risk financing,” says Andrew Seger, general counsel at Imprise Financial. “The arrangement also reduces some third-party insurance expenses while adding tax efficiencies. It’s clear why many small and midsize companies are getting into it — flexibility, control, expense reduction and tax benefits.”

These programs have been around for decades, but until recently they were only feasible for Fortune 500 companies because of the resources necessary to setup and manage them. Captive managers have since evolved, creating efficiencies that make it feasible for smaller companies. As it stands today, captive programs can be cost-effective for most any size business.

“Any company, regardless of size, type or industry, should look into captive insurance programs,” he says. “Otherwise, they could be missing out on an opportunity to leverage its features to get more competitive.”

Smart Business spoke with Seger about captive programs, how they’re structured and what makes a good candidate.

In what ways can captive insurance programs lower costs for companies?
Company owners and managers are in the best position to assess the risk profile of their companies. Captive programs enable them to select the risks they want to retain and which they’d prefer to transfer to an insurance company. This drives down outside insurance expenses.

By reducing payments to insurance companies and instead funding the captive program, the money accrues to the benefit of the owners and managers, creating investment income in a tax-preferred manner while reducing costs.

Who are the better candidates for captive insurance programs?
It comes down to what uninsured and self -insured risk the company has, how much money it spends on insurance and whether the company has a good claims history. If the company is spending six figures on a policy, but hasn’t had a claim in 10 years, it could easily retain that risk in a captive program.

Another factor is cash flow. Good candidates should be financially healthy with cash coming in — not necessarily high net income and high revenue, but recurring, reliable cash flow.

What should companies know about the program’s administrative responsibilities?
Most smaller and midsize companies hire a captive administrator to run the program. One of their functions is to navigate the regulations and compliance issues. A good captive manager takes a turnkey approach to the regulatory responsibilities at an affordable and transparent cost. But they also can be innovative in finding ways to leverage the benefits of the program to achieve the company’s long-term goals.

What tax benefits do captive programs offer companies?
Captive insurance programs can play a role in a company’s tax strategy. Insurance premiums paid by a company to the captive are tax deductible. And since insurance companies are subject to special tax rules, a captive can take deductions for loss reserves, resulting in deferred taxation. Even better, some programs qualify to exclude all insurance profits from taxable income.

The tax advantages of captive insurance are there for a reason. Congress put them in place to help captives accumulate assets quicker so they’re ready to bear the brunt of a catastrophic event. It’s essentially building a war chest to combat risk, but that war chest can be used for other things in the core business as an asset of the captive program.

Even though times have changed, many people still think captive insurance programs are too complicated or their company is not big enough, so they don’t consider them a viable option. These programs have become flexible and efficient, and are worth a closer look to see if they can be a benefit to the company. Some companies find it becomes a very valuable asset, not just for risk financing, but it helps contribute to the company’s long-term success and competitiveness.

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