What is a Captive
A pure captive is an insurance company which insures the risks of its parent. It is your very own insurance company. You pay premiums, and the captive issues you an insurance policy and covers any losses under that policy you incur. There are many permutations of the captive to fit specific needs, such as captives that issue polices to other related companies, captives that take on a degree of non-related risk, or group captives that have multiple shareholders and insure the risk of all the shareholders’ companies. For our discussion, we’ll keep it simple and address pure captives.

Self-Insurance (Without a Captive)
Sometimes insurance companies raise their rates, even if you haven’t had any claims, due to high claims by others in the industry or poor investment returns. If your company has better claims control than the industry average, why should you have to subsidize those with high claims? This may lead you to a decision to self-insure, and simply put aside the money you would normally pay for insurance in an account that you will use if you do ever have a claim. If you have no claims, the funds just accumulate in your name, and you have saved all the money you would have spent on insurance.

Other advantages of self-insurance are that you will never have to fight with your insurance company about paying out a claim, and the money that would have been premiums can generate investment income for you in the meantime. You’ll also have an incentive to get procedures in place to further lower your likelihood of future claims, as they are now paid out of your own pocket.

The disadvantage is that you have to pay out claims as they arise, and if you have a disastrous year you might not have the funds to cover the claims, so you still have risk you may not be comfortable with. Additionally, though you can deduct insurance premiums you pay to an insurance company, you get no deduction for setting aside money for a rainy day.

Captives
Captives are a formalized version of the self-insurance described above, which maintain the advantages while minimizing the disadvantages.

A captive can obtain access to the reinsurance market. This means that you can cede the portion of the risk you are not comfortable taking to a reinsurance company in exchange for premiums. These premiums are likely to be lower than what you would have paid to just buy insurance, and there will be more flexibility in exactly what risks you want to insure.

Additionally, depending on your jurisdiction’s tax laws and the structure of the captive, you may be able to deduct the premiums paid to the captive, as long as the premiums are reasonable. In some cases the profits of the captive may also not be taxable until such time as dividends are paid back to the owner.

Since an actual insurance policy is issued by the captive, you will also have proof of insurance should that be needed.

Establishing a captive will incur certain costs to run the corporation. Generally, the captive will need to have about $500,000 of premium per year in order for the various savings of the captive to outweigh the running costs. It is important to remember that you will be owning an insurance company, and to treat it as a business rather than simply a planning tool.
Captiva has helped many clients set up captives in Cayman, the British Virgin Islands and Anguilla. Visit us at www.captivamanagers.com or give us a call to discuss how a captive would work for your business.