Capitol Hill Encourages Business Owners To Own Their Own Insurance Company

Every year, millions of Americans, hundreds of thousands of business owners, states, counties and municipalities make decisions based on what Congress wants them to do.

We all know that states make decisions based on Federal funds they will receive.  For example, Federal dollars were attached to implementation of “No child Left Behind” and “Common Core” in public schools.

Also, every year countless business owners purchase new vehicles or equipment when their old vehicles and equipment are perfectly serviceable.  They make this capital upgrade because newer, better equipment benefits their business AND they experience significant tax benefits as well.  Why would Congress offer tax benefits to purchase new vehicles or equipment?   Well, there are a myriad of reasons.  New vehicles and equipment may be more energy efficient – think green.  They may help create manufacturing jobs and support U.S. industries.  Congress may want U.S. businesses to be strong, and new vehicles and equipment help ensure business strength.   New equipment may include financing which stimulates the banking industry.  The list goes on.  Or, consider the mortgage interest deduction and 401(k) which are specifically designed by Congress to encourage home ownership and retirement savings for all Americans.

It’s no secret that Congress uses incentives and tax laws to ENCOURAGE businesses to alter their behavior.  This includes incenting behaviors like hiring more workers, providing education to employees, choosing green energy, buying or accelerating the purchase of new equipment and, even, OWNING YOUR OWN INSURANCE COMPANY.  Clearly, business owners are not going to make a ridiculous purchase just to reap a tax benefit.

Congress wants small and medium sized businesses to own their own insurance company, known as a captive insurance company (CIC).  In the mid-80s, Congress passed captive insurance legislation that established the 831(b) tax election for small insurance companies.  This legislation opened the door for many small and mid-sized business owners to enjoy the same benefits of CIC ownership that large corporations had enjoyed since the 1950s.

Congress wants small and mid-sized businesses to own their own CIC for a variety of reasons.  Captive ownership isn’t the right move for all businesses, but for many businesses, the pros of CIC ownership outweigh the cons of CIC ownership.  A few reasons Congress encourages CIC ownership are as follows:

• Most businesses are under-insured but don’t want to buy more commercial coverage

• Businesses that own a CIC typically benefit from a vastly improved risk management approach

• Businesses that own a CIC tend to be forward-looking and better prepared to weather adverse events in the future

• CIC ownership boosts long term business viability which, in turn, is good for the economy and good for employees

• CIC ownership enables businesses and business owners to reap insurance profits and grow wealth (gasp)

For these reasons, and many more, captive ownership is encouraged by Congress.

What Is A Captive Insurance Company?

Simply put, a captive insurance company is an insurance company.  It is a C corporation and is licensed and domiciled like any large insurance company.  Captives also have their own reserves, policies, policyholders, and claims.  Owning a captive insurance company is a sophisticated way to self-insure, and captives are generally formed to insure the risks of a business, group of businesses and related or affiliated third parties.

What Are The Benefits Of Owning A Captive Insurance Company?

First, the parent company is able to benefit from a more robust risk management approach.  Specifically, the parent company or companies can now formally insure risks that may have previously been uninsured.  This could include many of the risks pointed out by FEMA at Ready.gov.

Second, the overall (or aggregate) wealth of one or more companies with a captive insurance company is almost always higher – significantly higher – than the overall wealth of companies without a captive insurance company.  This occurs for two primary reasons.  First, the parent company takes an expense as it pays its insurance premium to its captive.  This lowers the parent companies taxable income.  And, the captive does not pay taxes on the premium it collects (up to $2.2 million annually).  In 2017, Capitol Hill raised the limit to $2.2 million from $1.2 million – MORE PROOF THAT CONGRESS WANTS BUSINESSES TO OWN THEIR OWN INSURANCE COMPANY!  Second, the captive is able to earn a return on its reserve pool (or assets).  And, the captive’s asset pool has been amassed with pre-tax dollars, enabling asset growth on a larger starting base.

There are numerous risks that many businesses regularly face and informally self-insure.  Which means that if an event occurs, the business “bites the bullet,” often taking a loss, laying off workers and possibly facing partial or total closure.   With a small captive in place, making an 831 (b) tax election, businesses can formally insure risks not normally insured by third party insurers.

Adverse events are going to occur whether or not a business has a captive insurance company in place.  Businesses with a captive in place have a much larger pool of funds to address adverse events (typically 80% to 100% more) because captive assets are comprised of pre-tax dollars.  Hence, the captive effectively acts as a legal tax shelter for the premiums received from its insured.

Premiums are paid from the parent company to the captive with pre-tax dollars, and accumulate tax-free as reserves of the captive (up to $2.2 million annually).  Captive reserves can be translated into virtually any other type of asset (some captive domiciles have restrictions).  Hence premiums paid to the captive are in effect a “transfer of wealth” and are protected from the parent company’s creditors and lawsuits.

Over time, a well- structured captive can help ensure the survival of the business and often double a business owner’s wealth.  For small and mid-size business owners, this is one place where Capitol Hill “has your back.”  Take advantage of it!