I was watching basketball this weekend and was rather amused by the antics of the home team’s crowd, whenever the visiting team was shooting free throws. The home team’s student section and cheerleaders were behind the basket, screaming wildly and waving foam noodles behind the see-through plexi-glass backboard. Despite all the racket, most opposing players sank their free throws, and as I watched, I was reminded of playing basketball in grade school. My coach always said, “focus on the front of the rim and paint a black X there in your mind… and just float the ball just over the top half of the X.” I wish I could say it worked every time, but I can say that it worked often. The key was to focus on what was important and not get distracted by everything else.
Well, there have certainly been a lot of distractions surrounding captive insurance companies (CICs) and the 831(b) “small captive” tax election over the past year or so. Last Summer, the IRS placed “abusive” captive insurance companies on its “dirty dozen list.” The usual, speculative on-line fanfare followed the Service’s pronouncement with a flurry of foam noodles waving in the air. And, in a mid-December tax “extenders” bill, Congress modified code section 831(b) for small captive insurance companies. The changes were mostly positive, but also include “diversification requirements” that may require some small CICs to restructure their ownership or restructure their risk distribution pools. And, new CICs will obviously be required to meet the new guidelines to be eligible to make an 831(b) tax election. Not surprisingly, these modifications to 831(b) sent the foam noodles flying.
Keep Your Eye On The Front Rim
Fanfare aside, small captive insurance companies are still a game changing financial vehicle for small and mid-size businesses. Owning a captive insurance company is still the most powerful financial move that small and mid-size business owners can make. The risk management, asset protection and tax savings benefits are unparalleled.
What Is A Captive Insurance Company?
Simply put, businesses or their owners can choose to OWN THEIR OWN INSURANCE COMPANY. A captive insurance company is a licensed insurance company. Captives are formed to provide insurance protection to businesses and related entities. They aren’t licensed to sell insurance to the general public. They are usually owned by the business, business owners, a holding company or other related parties. With the proper structure, a captive can be owned by a trust for the benefit of heirs or owned by a business owner’s heirs. Businesses pay premiums as an ordinary business expense to their captive insurance company(ies). The captive issues insurance policies to the company. Captive policies are priced by an actuary and often verified by the domicile regulator. When the business files an insured claim, the captive pays it. Like commercial insurance companies, captives also accumulate loss reserves. Reserves can be invested in accordance with the captive’s Investment Policy Statement (IPS). The IPS is approved by the domicile. Captives can replace commercial insurance coverage or leave commercial coverage intact and insure other risks the business faces for which it is currently not purchasing third party insurance.
What Is An 831(b) Tax Election?
Small captive insurance companies may make an 831(b) tax election. “Small” captives are defined as having underwriting profits of less than $1.2 million annually. In 2017, this limit increases to $2.2 million. Underwriting profit is simply calculated as premiums received less claims paid. Captives making an 831(b) election are taxed at a rate of 0% (zero percent) on their underwriting profits. The illustration below is a business that pays premiums of $1.2 million to its small captive insurance company. Its captive makes an 831(b) tax election, and is taxed at a rate of zero percent. In this illustration, the resulting annual tax savings is $600,000.
How Are Small Captives A Game Changing Financial Vehicle?
Captives are a powerful financial vehicle that resolves a contradiction that most business owners and their advisors face. In business and in our human relationships, we usually expect to have to give up something to get something. For a business to enjoy more insurance protection and greater risk management flexibility, one would expect to have less money. In this regard, a captive insurance company can be a real game changer, enabling a business or business owner to have more insurance protection, greater flexibility and more money.
Why Are Small Captives Gaining Prominence?
Captive ownership has become viable and accessible for small and mid-size businesses in the last few decades. The Tax Reform Act of 1986, created the 831(b) section of the Internal Revenue Code, making it advantageous for small and mid-market companies to own their own insurance company. Also, in the 1990s, Governor Howard Dean of Vermont kicked off the “Domicile Wars,” when he decided to undercut New York for cost and capital requirements to set-up and operate a captive insurance company. To this day, Vermont is the largest captive insurance company domicile in the world. Other states followed suit, making captives more and more affordable and accessible.
Speaking Of Keeping Your Eye On The Front Rim, Do You Know Any Good Coaches?
CIC Services, LLC is a Risk Management consulting firm, specializing in the utilization of Captive Insurance Companies (CIC’s) to help organizations achieve their overall Enterprise Risk Management goals. We have been helping business owners manage risk through CIC ownership since 2005 by providing superior expertise, and full-service, turn-key captive management services. Our principals have over a century of combined experience in the insurance industry.
We understand the unique needs, goals, and fears of business owners. We have built our business by serving these entrepreneurs through the innovative use of captive insurance companies tailored to meet their individual needs and to help them achieve their goals and dreams.