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by Establishing a Captive Insurance Company
By Scott J. Altschul, Senior Vice President, Florida District, Key Private Bank –
Through 2015 it is estimated that the number of captive insurance companies operating across the globe will grow to 10,000. It is also estimated that 400 of the top S&P 500 companies operate their own captive companies. The reason for this growth and reach: captives can help businesses reduce costs, mitigate risks and produce tax advantages.
A captive is a closely-held insurance company whose insurance is primarily supplied and controlled by its owners. It provides organizations and business owners with an effective means to fund self-insurance exposure and maintain control of the risk management process. In addition to covering exclusions and deductibles on current policies some examples of uninsured risks often covered by captives include:
- Loss of reputation
- Inventory loss
- Punitive damages
- Product recalls
- Patent infringement loss
- Warranty
- Uncovered product liability
- Flood/asbestos/ mold
According to Conning & Company, a global provider of industry research services for insurance companies, more than 80 percent of a typical organization’s risk is not currently covered by commercial insurance. So, by creating a Captive, businesses can improve coverage protecting their long-term profits. They are also establishing an entity that can operate at a profit. This is accomplished by reducing costs and by paying out less in claims than it takes in premiums.
What is required to establish a captive?
Captives are not for everyone. A company should meet clearly defined criteria in order to gain the benefit of setting up a captive. First, businesses must document steady profits over a three-year period, have taxable income of $1,000,000 and an available cash flow of $500,000 to fund premiums. Finally, a business must have insurable and identifiable risks that are not currently covered.
In addition, a business must be willing to take a measured degree of risk. Because while captives can be profitable, the nontraditional nature of the risks they cover can also make them subject to higher claims volume.
However, with proper planning, administration and oversight, the captive is an effective strategy for businesses looking to save money while having access to coverage that is usually not commercially available at cost-effective pricing.
Who can benefit from a captive? What are the benefits?
Companies in most industries can effectively utilize a captive. Examples of industries whose businesses have substantial self-insured risk as well as traditional risk range from healthcare and medical practices to manufacturing, construction, hospitality, retail, transportation and others.
In many ways, captives operate like traditional insurance companies. The premiums received, along with any income earned on capital and reserves, are used to pay losses and loss-adjustment expenses. This is why businesses that are profitable and have significant available cash flow benefit from establishing a captive. Also, the captive must be capitalized to the point where it can meet potential exposures as well as all of its operating expenses. It also must assume real risk.
For companies that meet the criteria for establishing a captive, the benefits are diverse and significant. In addition to being able to cover risks not available for coverage in the commercial market and gaining greater overall control of risk management operations, captives also offer the following advantages:
- Asset protection – A captive operates as its own entity and is not a subsidiary of the operating business. Therefore it is not directly subject to claims against the primary operating business. In fact, liability is limited to the exposure on the policies it underwrites. This movement of assets from the operating company’s balance sheet can be a significant benefit, particularly if the company becomes financially troubled or the target of large lawsuits.
- Estate planning and wealth transfer benefits – Provided a captive makes sense for a business, excellent opportunities exist to transfer exceptional amounts of wealth to younger generations or key management without income, gift, estate or generation-skipping tax consequences.
- Tax saving opportunities – Premium payments up to $1.2 million a year are tax deductible.
Captives also offer a level of flexibility that allows owners to customize their overall risk management strategy based on year-to-year business performance. For example, in years when profits are high, operating businesses may transfer up to $1.2 million to the captive. Conversely, in a down year, an operating business can transfer as little as $200,000 to the captive. It allows for a very customizable approach.
How to establish a captive
Establishing a captive insurance company is not overly difficult. Typically, the IRS will recognize a captive as a valid insurance company provided: (1) the owner has a legitimate and compelling need for privately owned insurance, (2) saving taxes is not the sole purpose for its creation and (3) it engages in risk shifting and risk distribution, just as a traditional insurance company would.
For advice on setting up a captive insurance company, you should consult with your trusted wealth management professional to determine if establishing a captive is right for your business. Once it is determined that a captive may be a strategic benefit, your wealth management professional will work with you, your team of advisors and a captive insurance consultant to create and manage this effective business tool.
Key Private Bank is part of KeyBank N.A. (KeyBank). www.key.com
Investment products are:
NOT FDIC Insured • NOT Bank Guarantee • May Lose Value • NOT a Deposit • NOT Insured by Any Federal or State Government Agency.
This material is presented for informational purposes only and should not be construed as individual tax or financial advice. KeyBank does not provide legal advice.
Scott J. Altschul
Scott Altschul is senior vice president and investment solutions specialist with Key Private Bank’s office in Palm Beach Gardens, Fla. He helps high-net-worth clients manage and grow their wealth, leveraging the considerable resources of Key Private Bank’s local team of experienced financial professionals in various disciplines.
He joined Key in 2011, continuing a 20-plus-year career in the financial services industry, including experience as a portfolio manager for Merrill Lynch and a senior vice president of wealth management for a large financial institution. Prior to that, he practiced law for several years in New York.
A native of New York City, Scott earned his bachelor’s degree in economics from the State University of New York at Albany and a law degree from Hofstra University School of Law. He now lives with his family in South Florida.
An active member of the community, Scott volunteers as a YMCA youth coach for baseball and basketball and has served on the board of directors for the Victory School in Miami. He sits on the Boca Raton Estate Planning Council and is a member of the South Palm Beach and Palm Beach County Bar Associations. He also has served on the professional advisory committee for the South Palm Beach Jewish Federation.
Key Private Bank provides a highly personalized approach to addressing wealth management issues and simplifying the financial lives of its clients. Specialized practice groups and a consistent, disciplined approach helps clients define their priorities and create individualized investment strategies that help them reach their goals. Service areas include financial planning, tax strategy, estate planning and insurance solutions.
About the author: Scott Altschul is senior vice president of Key Private Bank in Palm Beach, FL. He can be reached at either 561-775-6537 or scott_j_altschul@keybank.com.
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