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Courtesy of Captive Dynamics.com esb@captivedynamics.com 1-760-366-4670


A Captive Insurance company is A privately owned, closely held insurance company formed to enhance the performance of its owner’s business.


Nearly anyone can have a captive insurer, but to receive the taxation benefits accorded to commercial insurers by the IRS: You must have a legitimate and compelling need to self insure. You must meet IRS tests of “Risk Shifting” and “Risk Dispersion”. May require significant funding, expert guidance and a fair chunk of your time.


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Legitimate and Compelling Needs to Self-Insure o Your annual premiums exceed $1,000,000 o You have considered insurance that was too expensive o You want to improve your overall risk management performance o Your policies contain discomforting exclusions o You are paying for uninsured (self insured) losses with after-tax dollars o You are using large deductibles or self insured retentions o Your premiums have sometimes fluctuated in a way that disrupted your business o You are unable to set aside reserves for future loss on a systematic, tax

deductible basis


Risk Shifting & Risk Dispersion Defined Risk Shifting: The risk of financial loss from an unexpected event is transferred from the party at risk to a second and financially separate party. Risk Dispersion: Numerous homogeneous and cooperating entities pool their funds so that each of them will share in the payment of a loss incurred by any of them. The entities should be organized in such a way that no single loss event is likely to affect more than a small percentage of them. The IRS may still be debating the exact meaning of these terms. Discuss this with your Captive Management Consultant


Most Uninsured Risks can be Covered in a Captive

Insured Risks

Workers Comp Excess Liability General Liability E & O Liability Property (Fire etc)

Uninsured Risks

Contractual Liability Punitive Damages D & O Liability Earthquake Flood Mold Deductibles, Retentions Litigation Expense


Risk Management Examples of Commonly Self-Insured Risks Construction Defects Directors and Officers Liability Contractual Liability Special Punitive Damages Employment Practices Liability Business Interruption Administrative Action Earthquake, Flood Self-Insured Retentions Jumbo Deductibles


Positioning the Captive What is the owner’s tax profile? What are the owner’s goals? How does the owner prioritize his/her goals? Will the Captive be owned personally or by an irrevocable trust? Where will the Captive be domiciled? Cost considerations Regulatory considerations Travel and time considerations Recreational opportunities


Considerations When Choosing a Domicile Domestic or Off-Shore? Local Taxes? Capitalization Requirements? Reserve Investments? Well Tested Regulatory Environment? Ease and Time of Travel? Is it a place you’d like to visit?


Your Objectives as a Captive Owner Federal Tax Benefits Control of Claims A New Profit Center

Lower Insurance Premiums Risk Management Estate Planning


Federal Taxation Captive Insurance Tax Issues are keeping lots of lawyers in high style. But a large Majority of captive managers know when a proposed plan is likely to offend the IRS. Before you pay a captive manager one dime, ask for his opinion on your tax situation, and what it will cost to validate that. It’s far too complex an issue to deal with via an Internet slide presentation.


Small Captives & 831(b) Tax Filings To be eligible for IRC 831(b) tax treatment a captive insurer must have earned premium of at least $350,000 and not more than $1,200,000. In that case the captive owner can elect to file under 831(b) and no tax will be payable on underwriting profit. Tax will be payable on Investment Income, Dividends, Interest & Capital Gains. If an 831(b) filing is made and then not taken in a subsequent year, the 831(b) filing cannot be taken again. A captive that is growing rapidly or is only marginally profitable may be able to justify using its profits to bolster its reserves against future loss, in which case it may pay little or no tax. Contributions to any insurance company’s reserves against future loss are based on actuarial calculations and reports.


Why Form a Captive? To Reduce or Stabilize Insurance Cost To Access Reinsurance Markets To Exert Control To Improve Average Claim Experience To Provide Ancillary Tax Benefits To Improve Profitability and Cash Flow To Provide a Means of Funding Retentions To Offer Estate Planning Benefits To Provide Coverage That is Not Otherwise Available


Captive Formation Process (1) Is a captive right for your company? One way to know is to Conduct a Feasibility Study Identify Potential Risks of Captive (Loss History) Analyze the Financial Impact on the Captive’s Owner Discuss Cash Flow and Tax Benefits Draft Operations Plan & Financial Projections Submit Captive Application to Regulator Incorporate and Capitalize Company


Captive Formation Process (2) If your company or professional practice does not yet enjoy the size and diversification to meet IRS tests of Risk Sharing and/or Risk Dispersion you may want to consider forming what is called a Protected Cell Group Captive. • Save money • Satisfy IRS Tests of Risk Sharing and Risk Dispersion • Be up and running in 3 – 6 weeks • Same eligibility tests for 831(b) • Comply with good risk management practices • Can be used to insure Medical Expense Stop Loss (MESL) deductibles. If you have a question, just call 1-760-366-4670


Captive Insurance - An overview