Can Your Business Benefit by Forming a Captive Insurance Company?

by: Smith and Howard

March 1, 2016

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Organizations in many industries and sectors can significantly improve their company’s performance through the use of captive insurance. However, some industries, including manufacturing and construction, are even better-suited to this risk management approach.

Captive insurance is essentially a form of self-insurance whereby the insurer is owned wholly by the insured. A captive insurance company is a legally licensed, limited-purpose property and casualty company. It does not replace traditional insurance coverage for typical coverage (worker’s compensation); rather, it augments that coverage for more significant risks. 

Fortune 500 companies have been applying this strategy successfully for many years. In fact, the tax code has permitted captive insurance companies since the 80s. However, it hasn’t been as widely known among growing privately held companies, and many business owners are unaware of how a captive insurance company can benefit them.

If you are the owner of a profitable business with stable earnings, you may be looking for a way to manage your insurance costs more cost-effectively. Forming a captive insurance company may provide a vehicle to better control risks and to cover hard-to-insure risks; it can help you fill gaps in existing coverage in a tax-efficient manner.

Covering Hard-to-Insure Risks

Owners and managers of manufacturing operations are typically more aggressive in their risk management procedures than their counterparts in other sectors out of necessity. However, you may not be covering some of your greatest risks because of premium costs. By creating a captive insurance company, you are able to provide the first layer in coverage for your business risks. These could include:

  • Product Warranty – taking back defective inventory
  • Deductibles on Existing Coverage
  • Significant Customer Concentration Risk
  • Uninsured Exposures
  • Safety
  • Environmental Liability
  • Cyber Security
  • Loss of Key Employees
  • Product Liability
  • Warranties, General and Professional Liability
  • Director’s and Officer’s Liability

Benefits of Captive Insurance

While the main benefit of captive insurance is the ability to save money on insurance premiums, there is something to be said about the control such insurance offers. Owning a captive provides business owners control over their costs and services, such as claims management and reinsurance, as well as control over who is a shareholder in the captive and the type and level of risk the captive shareholders are comfortable assuming.

For example, if we look at traditional insurance arrangements, the entire claims process is totally controlled by the provider rather than the business, and this can lead to costly errors and waste. With a captive, businesses have far greater control over claims administration and investigations, which can easily lead to more prolific cost-management performances as they relate to risk mitigation.

You’ll also be able to create a tax deduction for your operating business without creating taxable income for the insurance company. You may even be able to convert ordinary income into capital gains and build a war chest against future claims.

Word of Caution

While the benefits of a captive as outlined above are significant, those considering this option must understand that they will be operating a true insurance company and that there are potential pitfalls that must be avoided. It is critical to get guidance from qualified accountants and attorneys before deciding if a captive is right for your business.

The experts at Smith and Howard are available to help you assess the benefits of forming a captive insurance company for your company. Contact Marvin Willis, Debbie Torrance or Mark Abrams at 404-874-6244 or simply fill out our contact form and we will be glad to help.

How can we help?

If you have any questions and would like to connect with a team member please call 404-874-6244 or contact an advisor below.