There is no one-size-fits-all policy for business insurance. Companies have many different needs, and finding the right policy may take lots of time and energy. It is always important to consider your options carefully to ensure that your business risks are minimized and that you are using the most cost-efficient option.
Some businesses decide to create a self-insurance arrangement through a captive insurance company. These companies can provide cost savings and flexibility, among other benefits, but there are also many risks and consequences of forming this kind of entity — including tax issues. The Internal Revenue Service (IRS) monitors some of these arrangements with extra scrutiny.
What is a captive insurance company, when would you need one, and what are the associated tax perks? This is your guide to everything you need to know about captive and micro-captive insurance companies, including their risks and benefits.
Understanding Captive Insurance Companies
When Would You Set Up a Captive Insurance Company?
No Better Option
4 Benefits of Captive Insurance Companies
1. Investment Benefits
2. Lower Insurance Costs
3. More Specific Risk Coverage
4. Tax Benefits
These are significant benefits of captive insurance companies, and for some businesses, they can noticeably improve the profit picture. However, businesses can quickly get into trouble if they are not aware of the risks.
Biggest Risks of Captive Insurance Companies
- The IRS is especially skeptical of micro-captive companies. Always make sure the entity has been formed for risk and management purposes, and not just for the tax savings.
- The IRS requires risk distribution and risk shifting to exist for a transaction to qualify as insurance, and any suspicious transactions could be scrutinized to check for tax-evasion tactics.
- There will likely be additional costs associated with running a separate entity, including setup, administrative, and management expenses.
- A traditional insurance company spreads the risks among its insured parties. With a captive insurance company, that shared risk doesn’t exist, and reinsurance is usually used to further protect the insured. If a large claim comes along, the reinsurance cost could increase quickly.