Top 10 Captive Myths – #4 – Captives Are Only For Large Companies

An age old battle has been waged over the past three to four centuries regarding the role government is to play in the economy and in its policies toward large and small businesses.  It’s always tempting for politicians and government officials to favor large corporations because their wealth and scale can make it easy for the government to extend its control and influence in concert with those large corporations.  The wildly prosperous East India Company was practically an extension of the Crown as it spread commerce across the British Empire.  And today, we have banks, insurers and manufacturers like GM that have been labeled, “Too big to fail.”  For the most part, large corporations have been a positive force, achieving great efficiency and making a tremendous array of goods and services available to the people at affordable prices.  However, small and mid-size businesses create far more jobs and are more often responsible for inventions and innovation.

Wise politicians and statesmen have resisted this quasi-fascist view of the role of government in favoring large corporations and have, instead, opted for policies designed to level the playing field between large corporations and mid-size and small businesses.  President Theodore Roosevelt in the early 1900s realized that an America dominated by large corporate monopolies would be a miserable land characterized by modern day lords and surfs.  He recognized this was a recipe for wide-scale poverty and economic stagnation.  So, President Roosevelt and Congress embarked on a series of policies to level the playing field so small, mid-size and large corporations could all compete in a vibrant economy that would create real economic opportunity and potential for upward mobility to a larger swath of citizens.  His policies were successful and President Roosevelt became known as the “Trust Buster.”

Not surprisingly, there is a vocal group of “old guard” advocates in the captive industry who suggest that captive insurance companies should only be employed by large companies.  This sort of large company bias should be clearly recognized for what it is.  President Roosevelt thwarted large company prejudice over one hundred years ago and established a principle of equity in government policies toward all businesses.  This principle of equity was once again applied in 1986 when Congress passed the Tax Reform Act of 1986, leveling the playing field so small and mid-size business could form and operate their own captive insurance companies as large corporations had been doing for decades.   It’s worth noting that “small” captive insurance company legislation was a bi-partisan effort passed by a Democratic controlled Congress and signed into law by Republican President, Ronald Reagan.  This issue united both sides of the political aisle in America because small captive insurance companies are good for small businesses, good for long term business sustainability and good for America.

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)

Finally, competition among domiciles has made captive ownership accessible for small and mid-size businesses.  Until the late 1990s only the rich and famous in the large metro markets could access law firms that knew how to set-up captives.  Also, New York state was the only viable on-shore domicile for a captive with initial capital requirements of $1,000,0000 or more and total set-up fees of approximately $500,000.

In the late 1990’s Howard Dean, then Governor of Vermont, learned about captives and decided it was a way for the state of Vermont to make money.  Vermont was the second least populated state in the US, so Governor Dean put Vermont on the map in the captive insurance realm by undercutting the costs to establish captives in New York.

Since then, following Vermont’s lead, other states joined in.  Foreign domiciles also joined the fray to attract captives.  There are now over 6,000 small captive insurance companies in the world, and almost all Fortune 1000 companies have at least one captive.

Captives aren’t just for large companies!  Congress wants small and mid-size businesses to own captives.  The previously referenced Tax Reform Act of 1986 created the 831 (b) “small” insurance company tax election.  A small insurance company is defined as an insurance company that collects $1.2 million or less in premiums.  In most captive insurance company arrangements, premiums are paid by the parent company to the captive insurance company.  In return, the captive provides insurance policies to the parent company.  The 831(b) tax election allows small insurance companies to be taxed at a zero percent (0%) tax rate on underwriting profit.  Underwriting profit is simply defined as premiums collected less claims paid.  Hence, a small business could pay up to $1.2 million in premiums to its captive insurance company and the captive would pay no taxes.  The captive can be owned by the business, the business owner, business owners, heirs or other related parties.  Depending on claims, a captive can save up to $600,000 per year in taxes.