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A Closer Look at Small Captives

For over a century, captive insurance solutions have provided robust insurance coverage and cost benefits for companies. As a self-insurance model, captives are proven performers, offering coverages at less expense and more availability across industry sectors. Previously reserved only for the most well-funded corporations, small and midsize businesses have increasingly adopted captive insurance as an alternative to the traditional insurance market. Small captives deserve a closer look; in this guide, we will explore small captives and how they can provide substantial benefits to smaller business owners.

Captive Insurance: A Brief Overview

A captive insurance company is a separate insurance entity established and owned by a parent company or group of affiliated companies. Its purpose is to write insurance for the parent or group; some captives may also provide risk management services to its parent. Captives were developed to provide better coverage at lower costs than solutions available in the traditional insurance market; in some cases, companies unable to obtain or afford insurance for unusual or expensive risk profiles formed captives to gain valuable insurance protection. Captives also provide significant tax benefits for the parent or group, as annual premiums paid to the captive are deductible.

What is a Small Captive?

A small captive is defined as a captive insurance entity writing less than $1.2 million in annual premiums. This captive solution is often established by smaller and midsized companies or groups of companies to gain insurance protection at affordable rates. As long as the entity can demonstrate risk distribution/risk-shifting in its operations, it can qualify as an insurance company under U.S. federal tax guidelines. Small captives that insure high-severity, low-frequency losses typically elect to be taxed only on the entity’s investment income, again in keeping with prevailing tax code.

Small captives are growing in popularity as small business owners recognize the cost and tax benefits of this model. In fact:

  • Captives writing annual premiums of $1.2 million or less represent the largest segment of new captive formations in the United States.
  • There are over 1000 small captives in the U.S.
  • Small captive entities have led to growth in domiciles both in the U.S. and abroad.

What are the Advantages of a Small Captive?

Captive insurance offers many advantages to business owners. Small captives share these advantages, offering benefits such as:

  • Coverages for risks that are not available from traditional insurers.
  • More cost-effective insurance policies than are often available in the traditional insurance market.
  • Flexibility in coverage limits and in program design.
  • Simpler insurance contracts.
  • More control over insurance programs; central governance is in the hands of the parent, not an insurer.
  • Access to reinsurance markets.
  • Better risk management structure.

The cost and tax benefits alone are some of the factors that are influencing the growth of small captives in the United States. In simple terms, the traditional insurance market’s lack of flexibility and shifting structures means that insurance coverage may become too expensive for smaller business owners – if insurance coverage is available at all. Captives allow for insurance protection where the traditional markets cannot or will not.

If the captive is properly structured, any underwriting profit is returned to the parent or group and is not subject to federal income tax. Captive insurance can also be an efficient wealth-transfer mechanism, offering shelters for estate and gift taxes in some cases. Because captives are self-funded, cash flows are protected.

The expenses associated with forming a small captive can vary by domicile, and the management of the captive can also represent significant expenses. Smaller business owners must assess these expenses against the tax and cost-savings benefits before undergoing captive establishment. For now, small captive insurance firms are growing rapidly in the U.S. and beyond, allowing small businesses to gain comprehensive coverage at rates significant below those in the traditional insurance market.

About Caitlin Morgan Captive Services

Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.