The far-reaching benefits of establishing captive insurance companies

Essentially, any risk underwritten by a commercial insurer can be covered by a captive. Captives are private insurance companies established to meet the risk-management needs of a corporation or group of companies. A captive is a formalized form of self-insurance where the insured maintains the business deductions and risk transfer benefits of a traditional insurance premium payment. Just like a commercial carrier, captives are subject to state regulatory requirements including reporting, capital and reserve requirements.

Captive owners benefit from underwriting profits as well as favorable tax treatments afforded insurance companies. Captive owners are often the parent companies, key individuals or even trusts benefiting owners’ children. An owner can use a captive to cover a wide range of risks. A captive is not limited to insuring one business – an owner can use it to insure customers and suppliers, or a group of companies.

Both middle market companies and large corporations can use a captive insurance company (captive) to potentially reduce costs, generate profits or take advantage of varying tax laws. Business owners often use captives to create a secondary business that serves the needs of their primary business.

Captive insurance companies can provide sound risk management tools for many businesses and, with careful planning, a number of additional benefits for your closely held businesses.

Get coverage you need and tax benefits

Insurance coverage that is unavailable or too costly in the commercial market can be provided by a captive. This means that previously self-insured, under-insured and uninsured risks are converted into tax-deductible premiums paid to your captive. A captive also reports profits differently from other companies, which can provide a significant tax advantage, too.

Potentially lower costs and capture underwriting profits for your business

A large portion of commercial insurance premiums go to cover litigation, overhead costs and profits. Using a captive enables you to reduce or eliminate those portions of the premium and potentially benefit from underwriting profits yourself.

Stabilize insurance costs

Captive insurance may stabilize your risk management costs. Market factors beyond your control often lead to volatile insurance pricing. When you insure through a captive, premiums are determined by your company’s own loss experience rather than the experiences of a peer group.

Help protect assets and plan for the future

Assets in a captive are difficult for creditors to reach. Since you determine the ownership of your captive, you determine who owns the potential assets that may accumulate over time. While some of these assets will be required to back the policies issued by the insurance company, a portion of those assets may be available to benefit the company. As assets of the captive insurance company grow, they can often be distributed to the owners as tax-advantaged dividends or capital gains.

Manage cash flow and create a new profit center

Your cash flow can be significantly improved by creating a flexible premium payment plan. You also retain premium and investment income. By underwriting the risks of others, such as customers or suppliers, your captive can create a new profit center and help you retain key clients.

Managing and investing the assets of a captive is critical, yet often overlooked. The Wellspring team has been managing captive assets for decades, and investing captive assets is our expertise. Implementing a captive requires some heavy lifting, and it’s common for captive owners to suffer from “startup fatigue,” which can manifest in an ill-fitting investment strategy. We consider a well-structured investment portfolio to be integral to a captive’s long-term success.

Here are some of the most important considerations for captive investments:

Investment Policy Statement

A thoughtful investment policy statement (IPS) provides the foundation for captive asset management. A good IPS does the following:

Defines the primary objectives of preserving core capital and providing liquidity to meet current and ongoing claims

Outlines expected frequency and severity of outgoing cash flows (claims and expenses) to guide investment duration

States strategic asset allocations, diversification requirements and credit requirements consistent with the underwriting risk of the insurance policies

Provides a timeline for periodic review of actuarial changes and portfolio risk and performance

Regulated Entity

Captives are regulated insurance companies required to maintain adequate liquidity to cover claims. Investments are also subject to tax scrutiny by the IRS. Investments need to be consistent with the investment strategies and portfolios of traditional commercial insurance companies.

Liability Matching

Insurance companies have a stream of known liabilities (expenses) and potential liabilities (claims). Understanding the timing and potential severity of those liabilities provides a framework to match your captive’s assets to those liabilities. Creating this asset/liability glide path is at the core of managing insurance company investments and is fundamental to sound captive asset management.

We work with some of the best captive insurance service providers in the country, and we can work with you to find out if you’re a good candidate. Wellspring Financial Solutions does not design the legal or underwriting framework for a captive, nor do we provide accounting or actuarial work. We help captives manage their assets. If you are a business owner and are curious to find out if a captive is right for you, we’ll connect you with the right people who can help you explore how a captive may benefit you.