A captive insurance company is a privately owned insurance entity created by a business to insure its own risks. Instead of purchasing coverage from a commercial insurer, the business forms its own insurer, pays premiums into it, and retains control over coverage, claims, and reserves. Captives are regulated entities that must meet the same standards as traditional insurance companies.

A feasibility study is the first step. It evaluates your risk profile, current insurance costs, loss history, and financial capacity to determine whether a captive structure makes sense. Businesses that typically benefit have predictable risk profiles, strong safety records, and annual premiums that justify the cost of forming and operating a captive entity.

Section 831(b) of the Internal Revenue Code allows small captive insurance companies with annual premiums under a certain threshold to be taxed only on investment income, not on premium income. This can provide meaningful tax advantages but has also attracted significant IRS scrutiny. Proper documentation, actuarial support, and operational substance are essential to defending an 831(b) election.

The IRS focuses on whether the captive operates as a legitimate insurance company. Key areas include risk transfer and risk distribution, whether premiums are actuarially supported and reasonable, the adequacy of claims history and governance documentation, and whether the captive has genuine operational substance including independent oversight and active claims management.

A captive insurance audit is an independent examination of the captive’s financial statements, typically under both GAAP and statutory accounting standards. The audit evaluates premium recognition, loss reserves, related-party transactions, and coordination with actuarial reports. Captive audits require specialized knowledge because the regulatory and tax requirements differ significantly from standard commercial insurance audits.