Let’s start from square one. Captives, unlike insurance companies, are risk financing structures that do not pool risk between thousands of companies in exchange for a premium. They are expressly built to act just like and replace insurance companies by efficiently managing claims and paying losses from a special captive account themselves. 
The reason very large companies like Monsanto and Coca Cola utilize captives is because they have risk management departments that manage their losses and risk so well. Rather than pay premiums to an insurance company boosting the carriers profits they ARE the insurance company which means they pay premiums to themselves substantially lowering their risk financing (insurance costs) with the potential of earning profits on those same lower premiums.
Remember when you purchase insurance from a company like AIG you are essentially financing future losses from general liability or workers compensation claims due to employee injuries or future litigation. If your losses are low the insurance carrier, AIG, generates a profit. Coke and Monsanto essentially say they have such a high degree of confidence in their ability to mitigate and manage their future losses and claims that they want to keep that profit for themselves. Further they believe financing those futures losses themselves rather than have an insurance carrier finance those losses by charging for that service is a more efficient way of utilizing their cash reserves.
Micro Captives 5 key features & objectives:
- Substantially lowers your cost of Risk Financing (buying insurance)
- Having skin in the game should boost your results in terms of reducing losses.
- Gives you far more control than the present system which benefits the carriers and the brokers first as goals are misaligned.
- Should produce an ROI on your cash reserves which is how insurance carriers make money.
- Lowers your overall unit cost structure generating higher profits and/or greater market share due to better competitive position.
- A fraction of the cost to start and impliment compared to a standard captive arrangement.
Typically, captives are set up to replace commercial insurance carriers for one or multiple businesses with the initial goal to lower the companies’ risk based costs, eventually having the captive become a profit center. This is accomplished through all the above stated bullet points.
Micro-Captives are smaller captives designed for mid-sized companies under $ 1 billion in sales. The reason you usually only see large companies set up Captive Insurance companies is because it takes a lot of capital to fund it. Essentially, you need a lot of money to build up a large cash reserve to pay or fund future losses. Further, you need to set up infrastructure including a claims management intake team, legal representation, adjusters, actuaries, accountants, etc. These departments and functions come with the insurance carriers as one bundled product when you purchase insurance from a carrier such as AIG. When you set up a captive you need to build this infrastructure out for your own captive which can be a significant investment. This is why you don’t see many small businesses utilizing captives; UNTIL NOW!
Recently there seems to be huge interest and growth in Micro-Captives to efficiently fund certain tranches of risk, particularly high deductible programs. Section 831(b) of the U.S. Tax code stipulates different income tax rules for smaller insurance companies or captives.
The Captive must meet the following qualifications:
- The captive must qualify as an insurance company for tax purposes. Translated this means it must transfer risk in exchange for capital.
- It must be operated & regulated like an insurance company with sufficient capital reserves.
- The Captive must be a U.S. Taxpayer, either domiciled in the U.S. or domiciled off shore but having elected and qualified under tax code section 953(d) to be taxed as a U.S. insurer.
- The Captive’s gross premium income for the tax year in question must be less than $1.2 million. This premium threshold applies to all insurers in a single consolidated tax filing in 2016.
- Congress recently passed the Protecting Americans from Tax Hike (PATH) which increased the tax-free limit to $2.2 million in premium income beginning in tax year 2017.
WHAT’S THE BENEFIT Of A MICRO CAPTIVE ?
There are a few legitimately big ones. The first is that it allows small companies to really build a war chest. If you’re an S-Corp, or LLC any excess cash gets passed through to the owners’ personal tax return. This means contingent on your tax bracket, earnings and AMT you can lose almost 40% of those funds to taxes. Over several years that amounts to a lot of capital that could have been put to other uses where you could actually get an ROI.
In tax year 2017, if a business using a 831 (b) captive writes less than $2.2 million in premiums then the business is only taxed on investment income and NOT it’s underwriting income which could be substantial if your losses are low. This means that if the business paid $1 million in annual premiums this amount becomes a tax-deductible expense for the business while remaining an asset on the books of the company owned Micro Captive.
The purpose of this piece is not to provide the reader all the available information and calculations as it relates to Micro Captives. Quite simply, this is an intro piece meant to get folks who are buying first dollar or smaller deductible programs to begin to see a smarter more cost efficient program built specifically for small to mid-sized companies.
One of the reasons you don’t see these solutions being offered by your insurance broker or insurance carriers is because the net effect is it lowers the premiums you pay which do not benefit either of them as they are compensated on higher premium volumes.
If you would like to have deeper level discussion on how this solution may fit into your current insurance program, a Risk Advisor is waiting to field your call. Call (914) 357-8444 or simply CLICK HERE to schedule a call.
