3 Things You Should Know About Captive Insurance

 

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Accidents happen, and businesses carry business insurance to pay for any damages or repairs that result from unexpected accidents. Companies may purchase general liability, income, commercial property, workers’ compensation and cybersecurity insurance. However, some businesses have risks that are not covered by traditional insurance companies, so these companies may seek captive insurance.  

Self-Insurance

Captive insurance companies are subsidiaries of a parent company, so the parent company owns and pays their premiums to their insurance company. Their purpose is to mitigate their parent company’s risk in areas that are not covered by traditional insurance, such as an oil spill in an offshore drilling company. These companies only provide captive insurance services to their owners. Typically, larger corporations create these insurance companies due to their administrative and overhead costs.

Taxes

The Internal Revenue Service requires that insurance companies distribute and shift their risks, and captives must also follow this rule. Many captives are located in tax havens, such as islands in the Caribbean, to gain additional tax benefits. For example, companies that start captives try to deduct the insurance premiums they pay to their captives from their taxes even though they are essentially paying themselves. This may be considered abusive tax evasion.

Asset Accumulation

Captives accumulate assets. These assets result in significant surpluses or reserves for policy claims. These insurance companies need to keep a portion of their assets in case of an emergency.

Because it is quick and easy to draw money out of a captive, companies may seek to cash out the surplus over the assets they are required to save. However, but this may have substantial tax implications, especially if this money is not used on a covered emergency. Therefore, these companies must weigh the benefits of drawing out the money against tax penalties.

Companies in high-risk fields may choose to create their own captive insurance company. However, they should weigh the advantages and disadvantages prior to withdrawing the captive’s assets.