When is forming a captive insurance right for my business - First Horizon Bank

This is the second installment in a two-part series on the potential benefits of forming a captive insurance company, or captive.

The first installment covered what a captive is and how it works, the types of insurance captives can offer, and potential tax implications.

Who Should Create or Use Captives?

While the financial, tax, and control advantages of forming a captive are clear, not all companies should invest time and resources in forming their own captive or participate in any of the variety of captive models available.

The most common form of captive is the single parent captive insurance company (called a “pure” captive), which is owned and controlled by one company and only insures the risk of the parent company and any subsidiaries.

Perhaps the most important first consideration – in deciding to form a captive – is the ownership’s tolerance to accept self-insured risk. The second factor to consider includes any current stressful issues that a business owner is experiencing with its commercial insurance program. Finally, whether or not a business can afford to form their own single parent captive is determined by the start-up costs and annual levels of cash flow that the insured can dedicate to pay premiums into the captive.

Because of the trade-off between the commissions paid to commercial insurance brokers versus the annual, aggregate costs to administer a captive — which include captive manager fees, actuary costs, auditing costs, and state premium taxes paid — the break-even point for establishing a single parent captive is around $500,000 in annual premiums. If that is not possible, smaller businesses have the opportunity to participate in the alternative captive models of association, group, or protected cell captives with annual premiums as little as $100,000, while still reaping most of the benefits of captives.

In Tennessee’s statute, in addition to the Pure captive, there are six other captive structures that companies can choose:

  • Branch captive. This type is a U.S.- based arm of an existing offshore captive.
  • Special purpose financial captive. This is a reinsurance company that issues reinsurance contracts to its parent company and is owned and controlled by that parent company.
  • Association captive. This captive has two or more owners and is generally owned by members of one industry or trade association, who are the only businesses qualified to participate.
  • Industrial insured captive. This type is formed to insure the risks produced by a group of industrial ventures.
  • Protected cell captive. These entities allow for assets and liabilities of one captive program to be legally segregated from the assets and liabilities of another captive program. Also known as a “rent a captive,” this type of captive permits multiple varied businesses to obtain insurance coverages from their own smaller cell that is a part of the larger protected cell captive.
  • Risk retention group. An entity created under the Federal Liability Risk Retention Act and licensed in any one state to write liability insurance, potentially operating nationwide. Ultimately, the type and size of your company, the industry you are in, and the annual level of insurance claims you normally experience will help determine which type of captive makes the most sense for your business.

Getting Started

If you think that establishing a captive insurance company could benefit your business, you can hire a domicile-approved captive management company to conduct an initial feasibility study to determine if a captive program makes sense. Generally, this is either a no cost or low cost first step.

You then may engage that captive manager to conduct a more in-depth feasibility study to determine the pros and cons of captive formation, which then becomes the business plan for your application for a captive license from the domicile of choice.

The captive manager will help you determine your domicile of choice based on key factors such as minimum capital requirements, types of captives available, ease of doing business with the domicile, and cost factors such as premium tax levels, travel for one annual board meeting in the domicile, and required actuary and auditing requirements of the domicile.

Once the domicile approves a captive license, the captive manager will help to administratively form the captive in the state of the domicile, obtain a Federal Tax ID Number, and set up the banking arrangements necessary to fulfill the domicile’s minimum capital requirement and to provide for checking and investment programs for the treasury management of your premium deposits.

If would like to learn more about captives to determine if they make sense for your business, visit our website at firsthorizon.com/captives.

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