Happy Thanksgiving! Thanksgiving is often a time to enjoy our friends and families, and – dare I say – our heirs. Speaking of heirs, another fabulous benefit of a captive insurance company is that it provides a very efficient vehicle for the transfer of wealth to one’s heirs. But, before discussing this unique benefit, it’s worthwhile to review the primary reasons that businesses form their own insurance company – specifically a captive insurance company.
- To manage business risk by formally self-insuring certain risks with pre-tax dollars
- To protect assets from creditors of the operating business and its owners or other risks
- To realize profits and accumulate wealth inside of a separate business entity
These three are well known as the primary reasons that legitimate captive insurance companies are formed. However, a captive insurance company can also be an incredibly efficient means of transferring assets or wealth to one’s heirs.
A Common Challenge– There Are Many Obstacles Preventing the Efficient Transfer of Assets or Wealth to One’s Heirs
A challenge common to many business owners is the transfer of assets and wealth (including the business itself) to the owner’s heirs. Gifting rules make it difficult to transfer wealth or business ownership to heirs, and the “death tax” often leaves heirs with a large tax bill and little recourse but to sell off assets (often including selling the business) just to settle the estate. One solution that many business owners choose is to set-up businesses as suppliers or vendors to their core business. For example, a business owner may choose to lease land and capital equipment from a business owned by an heir. Or, as another example, a business owner may choose to purchase components or services (E.G. delivery, painting, testing, etc.) But, what if one’s heirs don’t want to own and manage a business?
This problem is easily solved by partnering with one’s heirs to set-up a captive insurance company. The captive can be partially or wholly owned by one’s heirs. And, it can be managed by a professional firm like CIC Services, LLC. Hence, the heirs will not be required to run the insurance company on a day-to-day basis. When a business forms a captive insurance company and uses it to formally insure risks that it previously informally self-insured, two relevant things happen. First, the business has a more comprehensive risk management strategy. A captive insurance company enables a business to insure a broader spectrum of risks. It also enables a company to access reinsurance markets, which can often lower total costs of insurance. And, the business receives a tax deduction for premiums paid to the captive. Second, the business transfers cash to the captive insurance company in the form of premiums.
There are additional benefits as well. Small captive insurance companies pay a zero percent tax on their underwriting profits under the Internal Revenue Code – up to $1.2 million annually. Thus, premiums received by the captive (owned by the heirs) in the example above are received tax-free even though they were tax deductible to the business that paid it. Thus, the reduced tax friction of the captive arrangement enables a more efficient transfer of wealth to one’s heirs.
But, what about claims? Won’t the captive have to pay claims on policies sold to the operating business? Of course it will. But claims paid to the core business from the captive are obviously needed in the event of a loss to the core business. And, the money “stays in the family” so to speak. Also, a properly structured and managed captive with stop-loss and reinsurance coverage can manage claims so that assets (reserves) are almost always growing inside the captive.
What Is A Captive Insurance Company?
A captive is a unique insurance company. It includes its own corporation, insurance license, reserves, policies, policyholders, and claims. It is a formal way for business owners to self-insure risk, and captives are generally formed to insure primarily though not exclusively the risks of one or more businesses owned by the same or related parties..
How Does a Captive Insurance Company Work?
A captive primarily insures its parent company or related companies. Hence, the parent company is able to purchase insurance from its captive, and it can insure risks that third party insurers will not insure or risks where third party insurance cost is unaffordable.
Some examples include (but are not limited to):
- Loss of a key account
- Loss of key personnel
- Loss of a license or certification
- Loss of a sales or distribution territory
- Loss of dealership rights
Premiums are paid from the parent company to the captive with pre-tax dollars. The captive can invest its assets mostly as its owners choose (some domiciles have restrictions).
Call us to discuss whether or not a captive insurance company or additional captive insurance company is the right move for your business.
Phone – 865- 386-4920
E-Mail – Tom@CICServicesLLC.com
Web – www.CICServicesLLC.com