Insurance giant, Marsh, recently released a benchmarking report which outlines trends in the U.S. captive insurance industry. The most surprising finding is that “only one-third of US captive owners treat their captives as insurance companies for US federal income tax purposes.” CAPTIVE INSURANCE TIMES recently covered the report in an article titled “Marsh Charts Captive Evolution” written by Stephen Durham on April 30, 2014. According to Mr. Durham, “The finding suggests that captives are being used more as a tool to generate operational and risk management value rather than for their tax efficiencies.”
The Marsh report is titled “The Evolution of Captives: 50 Years Later” and reports on the activities of 1,148 captive insurance companies under Marsh’s management. As such, it does not paint a complete picture of the U.S. captive industry, but this is a significant base size for a study (as it is estimated that there are over six thousand captives globally).
Not surprisingly, the report noted “Among the captives that are being treated as insurance companies for tax purposes, the number of new small captives, or so-called 831(b) captives, is trending upwards.” The article correctly notes that competition among domiciles has made captive ownership accessible to smaller companies for whom captives were out of reach a few decades ago. Specifically, Stephen Durham reported “captives, typically created by mid-sized companies writing less than $1.2 million in premiums, represent the most common new captive formations in the US over the past five years and have led to the significant growth of domiciles such as Utah, Kentucky, Montana, and Delaware.”
The article quotes, Julie Boucher, leader of Marsh Americas captive division. Julie said: “Marsh has always advocated that captives be viewed as a tool to help companies better deal with fluctuating market conditions, unstable regulatory environments, and global economic shifts, rather than just view them as a tax benefit.”
We would certainly agree with Boucher’s statement, but it does betray a degree of large company bias. First and foremost, captive insurance companies are risk management vehicles. However, for decades only large corporations enjoyed the benefits of captive ownership. This explains why many captives do not file income tax deductions. Large corporations often pay little out in dividends to their shareholders. And, to be blunt, large corporate CFOs don’t care how much taxes shareholders pay on the dividends they receive. Corporate CFOs often focus on both risk management and build-up of retained earnings as part of their overall financial strategy. As such, they view premiums paid to their captives as retained earnings. By choosing to not write off premiums paid to their captive insurance company, corporate CFOs can access captive assets as easily as they access retained earnings. Large corporations operate on a massive scale, and captives provide risk management transparency, broad claims history, improved risk management practices and access to reinsurance markets. It is also worth noting that many non-profits are insured by captives, so taxes are of no consideration in their decision to operate a captive insurance company.
Small businesses often can’t take advantage of the efficiencies offered by scale. Nevertheless, small businesses need robust risk management because a loss incurred by a small business is often of greater consequence to the business (and more likely to be catastrophic). And, small businesses play a vital role in our economy and account for a lion’s share of job creation.
For this reason, the United States has had a legislative, executive and judicial history of government intervention to level the playing field to help small businesses compete with large corporations. President Teddy Roosevelt, known as the “Trust Buster” took on large monopolies right after the turn of the 20th century, and government has largely followed in his footsteps since then. Small businesses face different challenges and threats than large corporations. They desperately need the benefits that captive ownership can afford, but their approach to risk management is (and should be) different than large corporations. Congress passed legislation in the mid – 80s creating the 831 (b) tax election specifically to help small companies enjoy the risk management benefits once reserved for large corporations.
To read the entire article in CAPTIVE INSURANCE TIMES, click the link below.
Since 2005, CIC Services, LLC has been a champion of small and mid-size business owners. We have helped business owners enjoy the benefits of owning their own insurance company.