Top 10 Captive Myths – #7 – 831(b)s Are Giving The Captive Industry A Bad Name

Every year, a vocal group of self-proclaimed captive experts trot out their marketing propaganda disguised as news articles or industry commentary.  In reality, these articles are marketing pieces and they often suggest that small captive insurance companies, often described as “831(b) captives,” are giving the captive industry a bad name.  One of the keys to propaganda is continuity and consistency of messaging, and years of droning on about supposed bad actors in the industry appears to be taking effect.  This year, the Captive Insurance Companies Association (CICA) decided to issue a statement on small captive insurance companies (to read about it, CLICK HERE).  And, the Vermont Captive Insurance Association decided to cover small captive insurance companies as a “Hot Topic” at their conference this Summer (to read about it, CLICK HERE).   The result is increased awareness and possibly concern over Myth #7 our Top 10 Captive Myths – 831(b)s Are Giving The Industry A Bad Name.

First, it is worth noting that this myth reflects the typical large company bias found among the “old guard” in the industry and some captive insurance company associations.  This large company bias is fueled by ignorance of the unique challenges facing small and mid-size business owners.  Hence small and mid-size business owners who set up captives to insure risks and bolster the long term viability of their businesses are unfairly labeled as suspect.  On the other hand, large corporations like Apple who run most of their profits through Ireland and pay almost nothing in U.S. taxes (to read more CLICK HERE) and Burger King, who is buying a Canadian restaurant chain and moving their headquarters to Canada to duck U.S. taxes can do no wrong.

Large company CFOs would never utilize their captive insurance companies for anything other than pure, unadulterated risk management.  They would never use their captive insurance companies as a means to smooth earnings.  And, of course, large company CFOs would never take advantage of the tax advantages that captives afford either.  Obviously, these statements are nonsense.  CFOs should use their captives for risk management, advantageous tax treatment and to smooth earnings when necessary to satisfy Wall Street.  This is simply smart business.  However, small and mid-sized business owners and their financial advisors shouldn’t be demonized for using the same tools Fortune 1,000 CFOs use to address the unique risk management and financial planning challenges that they face.

Conspicuous by its absence among the “old guard” and “old guard” captive associations is their failure to discuss the purpose of the 831(b) tax election as created by a Democrat Congress in 1986 and signed into law by a Republican President.  The Tax Reform Act of 1986 encouraged the formation of small insurance companies by small and mid-size businesses.   This was a clear move to “level the playing field,” enabling small businesses to reap benefits that were once accessible only to large corporations (see “Congress Wants You To Own Your Own Insurance Company” – CLICK HERE).

Second, it is also worth noting that small captive insurance companies are often demonized by the captive managers and attorneys who thrived when large corporations were busy setting up and operating their own captive insurance companies.  But the large captive insurance company market is largely “tapped-out,” and, not surprisingly, much of the growth in the industry is now driven by small and mid-size businesses.  The vast majority of Fortune 500 companies own one or more captive insurance companies.  However, the market for small captive insurance companies owned by small and mid-size businesses is barely penetrated (see our prior article discussing the massive under-penetration of the small captive market – CLICK HERE).

The “old guard” in the captive industry act “concerned,” wringing their hands and lamenting the growth of small captive insurance companies.  They suggest that their growth threatens the entire captive industry and gives the industry a bad name (see our recent article discussing the “old guard” and the true sources of their conduct – CLICK HERE).  At their core, the “old guard” in the captive industry demonstrate large company bias and discriminate against smaller businesses and small business owners.

In no way, shape or form are we defending the illegal or unethical deployment of captive insurance companies.  Yes, there are some bad actors in the industry.  But large companies and industries have their share of bad actors too.  Furthermore, there is currently no reason to believe that a larger percentage of small captives versus large captives are operated illegally or unethically.  Time will tell.  Bad actors should certainly be dealt with, but all small captive insurance companies shouldn’t be impugned by some bad eggs.

Most small insurance companies are done correctly and have resulted in stronger small businesses which bolsters the labor market.  The reality is the U.S. needs far more, not less small insurance companies.  There should be far more small captives than exist today, and the present growth rate is still surprisingly low in our estimation – see our article “Why America Needs 100,000 Captives” – CLICK HERE.   Competition among domiciles is finally making it attractive for small and mid-size business owners to experience the benefits of captive ownership.  Congress intended for the small captive market to grow to help strengthen small businesses across the nation.

Captive ownership is very good for small and mid-size businesses because it better prepares businesses to manage risk – and manage risk with a much more holistic approach.  Captives can also help businesses better weather uncertainty and threats.  Simply put, captives can help small businesses survive.  Also, small and mid-size businesses are often hollowed out by taxation, leaving them unprepared to weather calamity or market downturns.  A business with a captive in place, on the other hand, is better prepared to manage a wide range of risks and should have accumulated loss reserves to give the business buoyancy in difficult times.

If the industry is getting a bad name – and this is an “if” – it is being caused by old guard captive managers and attorneys who publish wave upon wave of negative marketing pieces disguised as articles.  They typically write under the guise that they are protecting “unsuspecting” (code for stupid or naïve) businessmen or businesswomen.  In reality, they are simply trying to grow their own businesses by scaring potential captive owners to steal them away from the captive manager who, in many cases, has worked hard to educate them about the benefits of owning a captive insurance company.  This vulture-like approach to marketing is far-and-away doing the most harm to the captive industry from a reputational standpoint.