Captive Overview

What is a Captive?

Captives are truly “Special Purpose Insurance Companies”. They are created primarily to serve a single corporation (or corporate family); members of an association; the clients/insured of an insurance company, agent or broker. The captive’s owner(s) dictate its underwriting and investment policies.

In more than 30 states, the District of Columbia and the U.S. Virgin Islands have enacted laws that regulate these Special Purpose Insurance Companies differently than traditional commercial insurers.

Why form a Captive?

  • Provide an alternate risk transfer/funding mechanism.
  • Smooth out insurance cost volatility.
  • Control coverage design, cost and administration.
  • Benefit from proactive risk management program.
  • May enhance strategic investment relationships and opportunities.
  • Creative financial tool.
  • Long-term fluid investment.

What Coverage is Provided Under a Captive?

  • Financial: Equity risks, Currency risks, Interest rate risks, Commodity risks, Credit risks, and Investment risks.
  • Traditional: Property risks, Liability risks, Casualty risks, Employee benefits, Business interruption, and Workers Compensation.
  • Non-Traditional: Price volatility, Inventory risks, Warranty risks, Environmental, Catastrophic risks, and Employment practices.

What is a “Small” Captive?

  • A small captive is a captive insurance company that meets the requirements of 831(b) of the Internal Revenue Code.
  • A small captive may have no more than $1.2 million in premium income annually to retain its favorable tax treatment.


"Brother-Sister” small captive insurance company transaction (diagram)

“Parent-Subsidiary” small captive insurance company (diagram)

Small Captives

Internal Revenue Code (IRC) Section 831(b) captives

  • Definition: Insurance company which receives premiums of less than $1,200,000 can elect to be taxed only on its investment income.
  • Captive owners are taxed on dividends and other compensation received from the 831(b) Captive and when the 831(b) Captive is sold or liquidated, its owners will pay tax on any gains on the value of their stock at long-term capital gains rates.

Insurance definition

  • President Bush signed the Pension Equity Funding Act of 2004 (the “Act”) into law on April 12, 2004. The effect of this legislation is to curtail the use of captives and to adopt a uniform definition of “insurance” as defined under Code Section 816(a) for purposes of 831(b) of the Code. The act was effective January 1, 2004.
  • Insurance definition: More than 50% of the business’s activities must be comprised of issuing insurance/annuity contracts of reinsuring risks underwritten by insurance. If a company’s investment activities outweigh its insurance activities, it may not utilize the elections under 831(b).

Advantages of Small Captives

Non-tax advantages

  • Insured company can directly (or indirectly through a trust, family members or other entities) control the operation and assets of the Small Captive Insurance Company.
  • As self-insured funds build in Captive, insured company may reduce or even eliminate its insurance coverage.
  • Capital accumulated funds build in Captive Insurance Company (in excess of reserve requirements) may be distributed to its shareholders or key employees.
  • Premiums paid to the Captive Insurance Company are removed from claims of creditors of the insured company.
  • Captive Insurance Company can be utilized in providing non-qualified deferred compensation for key employees of the insured company.
  • Direct access to reinsurance markets.
  • Coverage tailored to your specific markets.
  • Greater control over claims.
  • Cost Control.

Tax advantages

  • Premium is deductible.
  • Premium not taxable to Captive Insurance Company if total premiums retained are less than $1,200,000.
  • Distributions from 831(b) Captives are eligible for the reduced dividend/capital gains tax treatment.
  • Insured company can obtain an indirect tax deduction for funding non-qualified deferred compensation through key employee ownership of captive.

Procedures to set up Captives - What's Involved?

Step 1

  • Provide underwriting information.
  • Incorporate received underwriting information into a financial model to determine proposed captive’s financial viability.
  • Determine risks.

Step 2

  • Captive manager and actuarial firm will provide models that will include suggested premiums, risk and capitalization requirements.
  • Develop captive’s business plan, which includes marketing and financial sections.
  • Orchestrate a meeting with selected domicile’s regulators.

Step 3

  • Incorporate and capitalize captive.
  • Complete and file captive’s applications with insurance department for approval.
  • Audit of Captive.

Step 4

  • “Roll out” program.


Set Up Expenses

  • Management Services
  • Actuarial Services
  • Accounting Services
  • Legal Services
  • Insurance Department
  • Licensing & Review Fees
  • Total $55,000-60,000

Ongoing Annual Expenses

  • Depending on circumstances, generally $55,000-$60,000 annually.

* Fees may be paid by the Captive Insurance Company.

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