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The following is Part II of a six-part series of blog postings regarding whether a captive insurance subsidiary or one owned by the owners or affiliates of a company may represent an effective risk management tool that also provides economic benefits. Although there are various types of captive insurance, this posting and the four to follow will focus primarily on single parent/pure captives and how they might provide economic benefits for you or healthcare business. Part I of this series can be found here.

This posting discusses an alternative to ownership of the captive by the holding company itself — how a business’s owners considering implementing captive insurance as an enterprise risk management tool can also use it as an estate planning or family wealth transfer tool.

Owners of companies may find organizing and implementing a captive insurance company of which they are the owners a worthwhile strategic alternative to the extent:

  • They seek asset protection;
  • They seek an additional entity as a vehicle for additional personal wealth accumulation; or
  • They are interested in using the captive as an estate planning tool or are otherwise interested in exploring alternative family wealth transfer mechanisms.

Owners of the parent can organize a corporation or a limited liability company to qualify as a captive insurance company and to provide the insurance to the parent and the subsidiaries of the parent. Structured in this manner, it becomes an additional asset of the owner and, to the extent the captive insurance company is successful, it is a source of additional wealth accumulation apart from the parent company itself. Of course its reserves are to be used to pay claims of the operating subsidiaries of the parent company owned by the shareholders or members of the captive insurance company. However, to the extent the reserves are not used and they grow over time, the value of the captive insurance increases and the wealth of the shareholders or members of the captive insurance company increases. The owners of the captive are entitled to any dividends and distributions approved by insurance regulatory authorities.

As an estate planning strategy, the owner of the parent can also organize the captive insurance company with ownership of it in a lower generation or other heirs. Wealth is transferred to the lower generation, as the value of the captive insurance company increases. Ownership can also be transferred to trusts established for the benefit of a lower generation or others to whom the owner of the parent company desires to transfer wealth.  

One cautionary note as we conclude this second post of this series about captive insurance. Many owners of companies that spend $1.2 million or less in insurance premiums with third-party commercial insurers annually are enticed by the prospect of instead paying that amount to its own captive insurance subsidiary. It could then exclude it from the captive’s taxable income. They are also enticed by other potential tax benefits from operating a captive insurance subsidiary. The Internal Revenue Service is obviously aware of this and it has adopted rules with which businesses and their respective owners and management must comply to legitimately take advantage of the tax benefits. One of those rules is that the purpose for forming the captive insurance subsidiary must be primarily to meet the company’s legitimate business insurance needs as noted above. That is not to say that a company taking advantage of the tax benefits will cause the IRS to disallow those benefits; it is just that taking advantage of the tax benefits cannot be the main reason for forming or organizing the captive insurance company subsidiary. The captive must be a real insurance company – it must provide insurance. The two elements of insurance, risk transfer and risk distribution, are the subject of the third blog posting in this series.

Next posting: Risk Transfer and Risk Distribution