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10 Questions to Ask Before Forming a Captive Insurance Company
Here is a list of "10 questions" every prospective captive owner should answer when thinking about forming a captive insurance company. 1.) Do I need tax deferral and conversion strategies? Tax deferral is simply changing the time when a taxpayer recognizes income (and therefore has to pay tax on it). Conversion is changing income from ordinary income to capital gain. With a captive, the taxpayer lowers his taxable income, places it into a captive and, if he has a good loss record, takes the income out of the captive in the form of capital gain in 15-20 years. 2.) Have I started an asset protection or estate plan? A captive insurance plan is often part of a larger asset protection or estate plan. If you haven’t begun either of these, you should, and then fit the captive into one or the other. If you have started either (or both), the captive can still play an integral part in either. There are many different points to consider when analyzing the possibility of forming a captive insurance company. 3.) Has there been a problem with one of my existing property and casualty insurance plans -- that is, have I had a difficult time getting a claim paid, or have I have a hard time reaching my agent, or have I found the service to be lacking? With a captive program, you can tailor your coverage to fit your needs 4.) Do my current policies adequately cover all my risks? Even if you have an insurance policy, it’s likely big gaps exist. For example – do your current policies have cyber risk coverage? This is a fairly common exemption. Or, how much insurance do you really have for big areas of risk? These are critical questions you need to ask when thinking about a captive program. 5.) Am I able to actually negotiate the coverage terms with my current insurance carrier, or, do they hand me a policy to sign? Writing your own insurance contract is a tremendous advantage, as it allows you to add the policy provisions you want. 6.) Have I seen my insurance prices increase? Captives can provide stable pricing – meaning when the market for a particular line of insurance increases, a captive’s may not, depending on the experience of the parent company. This, in turn, gives the parent increased visibility in its earnings and expenses. 7.) Am I willing to add another set of corporate responsibilities to my schedule? Remember – by forming a captive, you’re starting another business. That means you now have additional corporate responsibilities to undertake – more reports to read, another set of corporate meetings to hold, etc.. Are you willing to engage in this? 8.) Am I comfortable placing money into a business enterprise for an extended period of time? All captives require original capital and surplus to pay claims. These payments are placed into the captive by the insured. In addition, the captive can’t do anything to jeopardize its financial position. So, after placing capital into the captive, you have to leave it there. Are you financially able to do this? 9.) Am I committed to lowering the cost of my risk? Central to the idea of forming a captive insurance company is the understanding the insured is going into the insurance business. As such, are you ready to undertake risk minimization strategies? For example, if your captive underwrites a cyber risk policy, are you willing to purchase anti-hacking services from third party venders? 10.) Am I committed to a long-term business plan? That is, am I willing to see this through for at least 3-5 years? Captives require a long-term commitment; you can’t simply start one and then end it a year later. At minimum, you need to commit to a 3-5 year time period to get the full benefit of a captive. original capital and ongoing funding.\ |
WHAT ARE THE BENEFITS OF A CAPTIVE?
Stable Insurance Premiums: a captive underwrites a limited number of insureds. This means it operates in an exclusive economic enclave, removed from the general market forces that determine premiums. As such, a captive will typically not have the same degree of premium variability as third party insurance providers. Using a Company’s Individual Loss Profile: while insurers used to look at each insured’s loss profile to arrive at rates, premiums are now dictated to the insured without any individual analysis. Part of the captive underwriting process involves an actuary looking at each company to develop premiums that account for that company’s risk profile. The Ability to Insure Previously Uninsured Risks: captive insurance typically fills gaps in third party coverage, eventually providing the insured with an “insurance tapestry” combining standard insurance and captive insurance. For example, doctors often use a captive to reinsure part of their medical malpractice coverage. Asset Protection: by placing assets into a stand-alone insurance company, the insured is also engaging in asset protection, meaning he is placing assets into a company that may not be the target of a creditor or a judgment in the event of a default or loss. Estate Planning Benefits: captive insurance companies can be structured in the exact same manner as family limited partnerships. The children are given highly restricted interests in the captive, which increase in value as the insured pays premiums. However, there are no estate tax implications because no one has died and there are no gift tax implications because the insured is purchasing a product for fair market value. |