SETTING THE STAGE: CURRENT STATE OF THE INSURANCE MARKET
2020 is now behind us, but the COVID-19 pandemic and all that it took in its wake are still very much a part of our lives. Although a return to normalcy inches closer with the advent of vaccines, organizations continue to wade through unchartered territories and historical losses caused by the global pandemic. All these costs are reducing insurance capacity while driving up premium rates. Renewals are up across all lines of coverages, and all industries are impacted. Since COVID-19 impacted pricing, availability of coverage, renewals, and underwriting trends, organizations are taking action as they seek to find cost-effective solutions for their insurance spend.
The most popular alternative option is a captive. Captives have been around since the 1950’s, and they currently account for half of all property and casualty premiums, according to a 2011 survey by Insurance Journal. The National Association of Insurance Commissioners estimates that today, there are over 7,000 captives globally compared to roughly 1,000 in 1980. While popular among the Fortune 1000s, with 90% reporting captive participation, middle market companies represent the fastest growing segment of the market.
This was the 13th consecutive quarter of increased premiums, with respondents reporting an average increase of 10.7% across all-sized accounts. Q4 2020 was also the 3rd consecutive quarter in which premiums increased for all lines, including Workers Compensation.Commercial Property/Casualty Market Report for Q4 2020
WHAT IS A CAPTIVE?
Captive insurance refers to a subsidiary corporation established to provide insurance to the parent company and its affiliates. A captive insurance company represents an option for many organizations, from Fortune 500 companies to nonprofits, that want to take financial control and manage risks by underwriting their own insurance rather than paying premiums to third party insurers.
It is no secret that the IRS is no fan of captive insurance companies, whether they are owned by large corporations or small businesses. An April 10 article in the New York Times covered the Service’s recent attack on small captive insurance companies but really came up short on telling the whole story.
WHY ESTABLISH A CAPTIVE? THE BENEFITS:
Establishing a captive insurance company often provides significant benefits to organizations and risk management professionals. The advantages of going captive include:
Coverage tailored to meet specific needs
Greater control over claims
Reduced operating costs
Control of cash flow
Potential tax benefits
Funding, underwriting and risk management flexibility
Access to the reinsurance market
Incentive for loss control
Capture underwriting profit
Potential additional profit center
Is Captive Insurance Right for Your Organization?
As organizations of all sizes seek to gain greater control over the costs and opportunities of risk management, captive insurance continues to increase in popularity as an alternative or enhancement to purchasing insurance in the traditional marketplace. For sophisticated companies, managing and financing risks are important aspects of overall business strategy.
Having a captive insurance company gives organizations of all sizes better control over risk management and can reduce the overall cost of risk. However, when deciding whether to form a captive, companies need to consider whether the organization’s insurance premiums are sufficiently large enough to justify the investments of time and resources needed to form and operate a successful captive insurance company.
While captive insurance companies can be valuable strategic tools, they are not always the best approach for every organization. An organization considering captive insurance should follow a methodical approach to determine whether a captive is the right solution. In addition, it is important for any organization considering the formation of a captive to hire professionals experienced in actuarial, accounting, tax and legal issues. Well-planned captives are formed for long-term risk management solutions; the most successful captives are those where the parent company views the captive as a long-term strategy.
The world of captive insurance can be confusing, with so many different structures available, and so many different factors that need to be taken into consideration. Contact the AHT Captive Team to learn if captive insurance is right for your business.
TYPES OF CAPTIVES WE OFFER
This type of captive insures the risks of related companies and is owned and controlled by the related company or its affiliates. It is often the choice of larger insureds with more sophisticated risk management profiles. It is the most common form of captive and can be organized under the laws of any jurisdiction with a captive insurance statute.
This type of captive is a licensed insurer or reinsurer that is formed and owned by an industry, trade, or heterogeneous group of employers, and is strictly for the benefit of its members. A group or association captive provides a vehicle for insureds that may be too small to effectively assume a large risk position within their own single parent or sponsored captive arrangement. Participants in this type of captive can share or pool their insurance risks and efficiently spread the fixed costs of the captive among its many members.
RISK RETENTION GROUPS (RRGs)
RRGs are liability insurance companies owned by its members that are formed under the auspices of the Federal Liability Risk Retention Act. RRGs allow businesses with similar insurance needs to pool their risks and form an insurance company that they operate under state regulated guidelines. RRGs may be formed under a state’s captive or traditional insurance laws and even if domiciled in one state, it may do business in any other state by completing a registration process and designating the state’s commissioner as agent for service of process. Unlike other captives, RRGs may write directly in states where they are registered without obtaining a license.
831b MICRO CAPTIVES
A micro-captive is a small captive insurance company that may be taxed under Internal Revenue Code § 831(b), which provides that a captive qualifying to be taxed as a US insurance company may pay tax on investment income only in any year that its written premium is at or below the threshold for the applicable tax year. Micro-captives became popular because, if a captive is taxed under § 831(b), it does not pay tax on its underwriting income. It pays income tax only on its investment income. The underwriting profit can either be returned as a shareholder dividend or remain in the captive as surplus.
Common Myths & Misperceptions Cleared Up:
READ HERE: What Every CPA Needs to Know about Captives: by Michael DiMayo, Oxford Management Group
READ HERE: Keeping Captives Compliant: by Michael DiMayo, Oxford Management Group
Establishing a captive also means that an organization will need to choose a domicile for the captive. A captive domicile is the state, territory, or country where a captive insurance company is located. The domicile licenses captive insurance companies and also has primary regulatory oversight over the captive. This means a captive may only be established in a domicile that has the appropriate captive legislation in place. An owner who wants to form a captive must submit an application to the domicile regulator for review. Internationally, Bermuda is the top domicile, followed by the Cayman Islands. Both Bermuda and the Cayman Islands have well-established infrastructures and favorable regulatory climates, which is why many organizations choose them as captive domiciles. In the United States, Vermont is the top domicile.