Comprehensive Guide to Structuring an Effective CAPTIVE INSURANCE Company

This whitepaper delves into the strategic advantages of establishing a captive insurance company, highlighting its role in providing cost-effective self-insurance solutions for businesses. The document offers an in-depth analysis of how this approach not only enhances coverage but also serves as an efficient and legitimate tax structure. Moreover, it elucidates the potential of captive insurance as a dynamic instrument for safeguarding business interests and boosting profitability, emphasizing the importance of its proper utilization.

Insurance is an essential safeguard for businesses to mitigate the risk of financial loss. For many companies, the formation of a captive insurance entity presents an attractive strategy for self-insurance. This approach is not solely advantageous for tax benefits, but also acts as a catalyst for enhancing profitability and wealth accumulation for business owners.


A captive insurance company represents a transformative method for businesses to self-insure, offering reduced costs and enhanced coverage. This entity, a wholly-owned subsidiary, delivers tailored risk mitigation for its parent company or a consortium of related businesses. Essentially, a captive insurance company is established to cater to the specific requirements of a unified group, such as an affinity group or association. In this model, the members are both the proprietors and contributors to the loss reserves, collaboratively managing the operations for mutual benefit.


Better Control of the Company

In a captive insurance company framework, you have the autonomy to establish guidelines within legal boundaries, select deductibles, set maximum compensation limits, and define the criteria for claims processing. Additionally, it facilitates the provision of services such as loss control for the owners, which can be financed by the insurance entity as a strategic investment in reducing claim incidents.

Option to Stop Losses

Implementing stop-loss measures is a critical component of a captive insurance company’s strategy. These provisions are designed to shield owners from excessively large claims, ensuring that coverage remains both comprehensive and economically viable.

Safety Culture

Owning a share in a captive insurance company naturally incentivizes minimizing losses. Being a stakeholder in such a company often leads to a heightened focus on employee safety, which in turn results in fewer claims due to reduced injuries. This effective risk management not only decreases the need for substantial contributions but also fosters increased profitability for the company.

Predictable Premium Amount

During renewal periods with traditional insurance carriers, businesses often face the daunting prospect of unexpected premium hikes, complicating financial planning for business owners. However, within a captive insurance company, being closely informed about its financial health allows for a more accurate anticipation of changes. This understanding often means that increased profits could lead to premium reductions rather than unexpected increases, offering greater stability and predictability in budgeting.

Tax Benefits

The parent company can benefit from tax deductions on premiums paid to the captive insurance company. This arrangement opens the door to various tax-saving opportunities, including gift and estate tax reductions for investors/owners, as well as income tax savings for both the parent company and the captive. Additionally, it offers a pathway to accumulate wealth through tax-advantaged methods and facilitates the distribution of profits to captive owners at favorable income tax rates.

Other Non-Tax Benefits

Enhanced protection of assets from claims made by business and personal creditors. A reduction in the insurance premium costs typically incurred by the operating company. Access to the more economical reinsurance market. The capability to secure coverage for risks that are traditionally uninsurable.


A captive insurance company is a specialized entity owned by a parent company, dedicated to underwriting the insurance requirements of its subsidiaries. This entity assumes responsibility for the insured risks, ensuring accountability to its insured entities. Generally, the policies offered by a captive mirror those of commercial insurance, albeit often in a more streamlined form. It is responsible for issuing policies, handling claims, and adhering to specific regulatory standards.


– (IRC 162) Are premiums normal and essential?
– (IRC 482) Are they distributed reasonably?
– (IRC 7701(0)) Are they financially viable?
– Are there tax implications on self procurement?


– Is the captive insurance company formed for tax reasons?
– (IRC 801, 816, (b))? Is its premium income eligible for special treatment or exemptions?
– How are investment revenues taxed?
– Are there any premium taxes?


– Are the allocations eligible for dividend and / or capital gain treatment preference?


What are allowed in a captive insurance arrangement?

– The parent company in a captive insurance arrangement is allowed to self-insure, withhold insurance premiums paid to the captive, control the investment of the premiums (consistent with regulatory requirements), and is eligible to get tax-free treatment with the liquidation of the captive.
– Captive insurance companies are allowed to deduct a portion of their reserves for unpaid claims – IRC 832(b)(5) and IRC 846.
– Captive insurance companies are generally allowed to reduce the recognition of collected but unearned premium income to 20% (example: 80% deferral on unearned premium reserves). – IRC 832(b)(4)(B)
– As losses are paid out over time, the insured would recognize a tax deduction (under a self-insured arrangement). But the insured would not generally be able to deduct a reserve for losses.

Eligibility for special tax elections

– Under IRC 831(b), insurance companies with less than $2.4 million in annual premium income can make an election to be taxed solely on investment income.
– Under IRC 501(c)(15), insurance companies with $600,000 or less in gross receipts may be eligible for tax exempt.
– Under IRC 953(d), a captive insurance company that is formed in a foreign jurisdiction can make an election and be taxed as a US corporation. Opting for taxation as a U.S. corporation avoids the federal excise taxes on insurance premiums paid to a foreign insurance corporation and may eradicate withholding tax burdens.

IRC is not defined by the IRC (Factors in Focus)

The term “insurance” is not defined by the Internal Revenue Code. Four factors are the focus of the courts:
1. Risk Shifting: The transfer of the impact of possible loss from the insured to the insurer.
2. Risk Distribution: The distribution of risk to a larger population to decrease the changes that a single loss event will affect all insured parties in the same way.
3. Insurance Risk: Normally implied within the first two factors. The insured must encounter some risks, or insurance cannot be present.
4. Insurance in the Commonly Held Sense: With emphasis on whether the insurance arrangement itself is legal, the captive should be organized and operated as an insurance company and certified as an insurance company (with its primary business as an insurance).

May be subject to state and/or federal excise taxes

Captive insurance companies may be subject to state and/or federal excise taxes.
– Premium taxes owed by the captive insurance company or a licensed “fronting” company.
– Self-procurement taxes for insurance companies that autonomously procure insurance.
– Federal excise taxes if the insurance company is formed in a foreign jurisdiction.

Tax-Exempt Captive Insurance Companies

– Insurance companies with $600,000 or less in gross receipts are free from federal income tax if insurance premiums at least 50% make up of those gross receipts.
– Due to the low threshold ($600,000), 501(c)(15) tax-exempt insurance companies are rare
– The threshold cannot be avoided by forming several related insurance companies ( given that threshold limit applies on an aggregate basis).


How does a captive insurance company differ to a captive insurance agent?

A captive insurance agent only works for one insurance company and is constrained from selling rival’s products.

Is captive insurance a real insurance company?

Forming a captive insurance company goes beyond being a vehicle for self-insurance. It is an accredited, regulated insurance company that is lawfully established in one’s home state or nation. It is a legal entity that complies with the rules and laws of one’s domicile (that is totally separate from the businesses owning it).

The standard requirements for capitalization and reserves, detailed actuarial requisites, periodic reviews, captive management, and other reporting obligations are needed when forming a captive insurance company.

Where does your money go when you pay premiums in a captive insurance company?

In a traditional insurance company, the premiums that a business pays are tagged as merely an expense (to cover for a specified period) but do not yield equity. In a captive insurance company, while the premiums are tagged as an expense (for tax purposes), the payments actually go as an investment of capital. These investments, along with the premiums paid by the other members of the group, become the fund of the insurance company that are used to pay out claims. Any remaining funds (not used for claims) can be grown through investment. If the claims amount is lesser than the expected amount in a year and the coffers are wisely invested, there’s a possibility that the contributions of the owners would be scaled back in the next few years resulting to an enhanced cash flow.
Simply put, choosing to invest in a captive insurance company gives you not only the coverage that you want, but it is also financially advantageous for you because of the underwriting profit that it earns.

What are the different types of a captive insurance company?

There are different ways to set up a captive insurance company:

“Pure Captives”: Where only the owners are being insured.
“Single-Parent Captives”: Wherein there’s a single owner (i.e. a Fortune 500 company)
“Group Captives”: Where there are multiple owners (can be from a single industry so their special risk needs are being covered).
Captive insurers can be either formed in the US or in several jurisdictions worldwide (as every country has its own restrictions on capitalization and the required surplus amount to retain).

What’s the process when forming a captive insurance company?

Forming a captive insurance company requires an extensive process. You are required to conduct some feasibility studies and financial projections, identify the domicile, and prepare and submit the application to get an insurance license. You would need a qualified insurance manager specially during the formative phases.

It is necessary that you have ample capitalization for the initial setup of the captive considering the level of the projected risk and the requirement of the chosen domicile. Using irrevocable letters of credit can be used for the primary capitalization can be allowed in some cases. This irrevocable letter of credit can be acquired by the sponsor applying to the bank. The credit facility charges some fees for the issuance of such and there’s a possibility that the sponsor’s other borrowing capability can be affected.

A vital function that should be given emphasis during the formative stages is the identification of risks that would be insured by the captive. The operating entity is currently paying premiums to maybe one or more commercial insurance companies to safeguard it from particular risks (which some of these risks could be catastrophic for the company if they were to occur without the insurance). The objective of the smaller captives would be to preserve the transfer of these terrible risks to the commercial carriers. But the underwriting associated with the more controllable risks would be assumed by the captives.

The policies should have bonafide insurance risks that have low chance of occurring. In the case of a higher risk policy, it should be included in the guidelines that the captive should be able to buy reinsurance at premiums that are cheaper that the premiums that it charges the parent company (as a way to protect the captive). Annually, the premiums that are paid to the captive as a surplus of the claims and operating expenses will be transferred to the earned reserves account and can be used for more aggressive investment activities. But because a real insurance requires a definite amount of fortuity, the captive should be very careful in choosing the “risks” to insure. Having said so, the payments made into the captive would take on the portion of deposits into a dipping fund to help settle an existing liability.

The flexibility to select the higher deductible levels on the existing assets and casualty insurance policies is one of the risk management advantages of a captive insurance company. Thus, the captive should be careful when choosing the risks that it is ready to assume in order to reduce, if not totally eliminate claims experience.

Why do companies decide to form a captive insurance company?

The option to form such exists when the parent company…

– Is unable to find an appropriate outside firm to cover them against specific business risks
– Finds better tax savings with the premiums paid to the captive insurer
– Finds the insurance as more affordable
– Discovers that the insurance can provide better coverage for business risks of the parent company.

How do the members of the captive insurance company work?

Company owners who decide to group together and form their own captive insurance company work with an advisor to explicitly develop a systematic understanding of the risks related to the nature of their businesses. The advisor also develops a tailored policy indicating the risks and price them accordingly.

As an alternative to paying premiums to a commercial insurance carrier, business owners who form the captive insurance company invest in their captive insurer which in essence means they are giving part of their working assets at risk. But fundamentally, their annual outlay in the captive is so much lesser than what they would have paid had they chosen a traditional insurance.

How does a mutual insurance company differ from a captive insurance?

In a mutual insurance company, policyholders are the owners but they don’t have control over the insurer.  Though they are given the right to assign deputy approving members of the board of directors, they cannot directly control the company. Insured companies lose their ownership once they stop making premium payments. On profitable years, mutual insurance companies have the authority to issue dividends. But most of them only use those profits to augment their funds. In a captive insurance company, the owners (who are also the policyholders) are the people that it insures who both have ownership and control of the company.

What type of coverage does a captive insurance company have?

The coverage that a business receives from an insurance company in an open market may be limited or bear some deductibles that are beyond your comfort level. This means that you have no choice but to settle on whatever coverage there is available. What businesses need are insurance benefits that would meet their own needs depending on the type of business that they have.
This is the allure of a captive insurance company because the coverage is tailored specific to the realities of the business. With a captive insurance company, you won’t be paying for additional coverage that your business doesn’t need while covering risks that are specific to your industry. You will also be given a chance to add some coverage that are not part of the general policies (i.e. strong coverage for cybercrime).

Here are some examples of coverage that a captive insurance company provides:
– Employee healthcare insurance
– Workers’ compensation
– Product liability
– Professional liability
– Extended warranty and service contracts
– Cyber security and terrorism
– Other company-specific risks
– Increasingly, property insurance

Risks can be modified according to the type of industries or circumstances and may offer coverage not commercially available (e.g., for COVID-19 or defense by firms not normally approved as panel counsel by insurers).

How do you operate a captive insurance company?

Despite the charm of the tax benefits associated with the smaller captives, company owners sometimes forget that the captive must operate as a real insurance company. This is where the role of an experienced and competent captive management company comes in. The following are needed when operating a captive insurance company:

– Annual actuarial reviews
– Annual financial statement audits
– Continuing tax compliance oversight
– Claims management
– Other regulatory compliance needs that are needed for the daily management of a captive insurance company that are outside the skills of the majority of the general business people

Similarly, the participation of the management company in the investment activities of the captive is necessary from a planning standpoint to guarantee that the captive’s liquidity needs are met.

Why do companies decide to form a captive insurance company?

The option to form such exists when the parent company…
– Is unable to find an appropriate outside firm to cover them against specific business risks
– Finds better tax savings with the premiums paid to the captive insurer
– Finds the insurance as more affordable
– Discovers that the insurance can provide better coverage for business risks of the parent company

How can you make a captive insurance company be financially advantageous for your business?

Managing a business’ risks is the core reason for forming a captive insurance company. Getting profit from the company’s sound underwritings is an additional benefit because captive insurers generally allocate dividends to the owners.

To increase returns, the amount that would be spent on claims must be reduced. How?
– Having better business practices through ensuring safety procedures are in place
– Reviewing each claim (reasons and occurrences of the claims) to get a better understanding of how each claim should be handled moving forward
– Controlling expenditures

The Captive Insurance Committee Structure

Captives (just like all insurers), must deal with underwriting, claims, investment of premiums and other funds, and audit responsibilities.

Underwriting Committee: This should be established along with underwriting standards, lines of authority, and procedures if the captive is formed to entertain risks other than that of the owners.
Claims Committee: This is established to regularly assess claims reports to determine trends, underwriting violations, and reserving practices. It may be involved in selection of adjusters, attorneys where appropriate, and reserve management. Third-party administrators can also manage claims in exchange for payment of a fee. Third-party administrators assume no risk, nevertheless, and spend the captive’s money.

Investment Committee: Funds are received upon its formation and should dutifully invested so that they are available to pay claims. Investments are usually restricted by state law. Earnings from these investments can, over time, be substantial. If funds are inappropriately managed, they can cost the owner considerable sums and even put at risk the continuation of the captive.

IRS Revenue Ruling

IRS Revenue Ruling 2002-89 and 2002-90 detail the rules on how captive insurance comprises insurance for federal income tax functions to make premiums deductible. Captive insurance is considered a real insurance (where premiums are deductible) based on the following safe harbors:

– 50% Third Party Insurance Safe Harbor: The captive insurance company is comprised premiums from at least 50% third-party insurers that are unrelated to the owners (to assure adequate risk distribution)
– Twelve Insureds Safe Harbor: The captive insurance company has not less than 12 insureds (each should have 5%-15% of the total risk). Again, this is to ensure that there is sufficient risk distribution.
Revenue Ruling 2002-89

In December 2002, the IRS published three Revenue Rulings which dealt with captive insurance companies. In Revenue Ruling 2002-89, the Service ruled on the issue of the deductibility of premiums paid by a parent to its wholly owned captive subsidiary. The Service addressed the issue using two fact patterns. In situation 1, 90% of the premiums received by the captive were received from the parent of the captive and 10% was received from unrelated third parties. In situation 2, the premiums received from the parent by the captive constituted less than 50% of the total premiums received and more than 50% was received from unrelated third parties. The Service ruled that the arrangement in situation 1 lacked the requisite shifting and risk distribution to constitute insurance for federal income tax purposes.

Hence, the premiums were not deductible. In situation 2, the Service relying on the holdings in Ocean Drilling and AMERCO, ruled that risk shifting and distribution were present, and therefore, the premiums paid were deductible. In addition to the captive receiving more than 50% its premiums from unrelated third parties, the ruling contained other important factors including the following:

– The premiums were established according to customary industry rating formulas,
– The parties conducted themselves consistently with the standards applicable to an insurance arrangement between unrelated parties,
– The parent did not provide any guarantees of the captive’s performance,
– All funds and business records were kept separately, the risks were homogeneous and the captive did not loan any funds to the parent.

Revenue Ruling 2002-90

In Revenue Ruling 2002-90, twelve geographically dispersed subsidiaries of a common parent company (each subsidiary operated in a separate state) insured their professional liability risks with a captive insurance company (also owned by the common parent). The IRS ruled that the payment of premiums by the 12 separate subsidiaries to the captive did result in risk shifting and that the transaction did constitute insurance for federal income tax purposes. The IRS relied upon the courts in Humana and Kidde in reaching its conclusions. Revenue Ruling 2002-90 provided confirmation that the IRS would respect an insurance arrangement between ‘brother-sister’ entities.


What if I sell the business? (What happens to the Captive? What are the options?)

Transfer the use of the captive to a new business activity OR go through a normal dissolution process (of the C-Corp and unlicensing the reinsurance company). The captive can also be repurposed. The captive is a C corporation with an insurance license. The owners of the captive can choose to cancel the insurance license when it is no longer needed. The Captive becomes a regular C corporation that can be used for some other business purpose.

What are the best utilizations of a captive in my business?

To build tax efficient reserves through insurable risks that exist in the business. Captives can provide business insurance coverages that are not commercially available or for which premiums are excessive.

How can I best liquidate?

TAXATION – LIQUIDATION: There is really only a short list of liquidation mechanisms being a reserve asset of a C-Corp (the captive itself); a qualified dividend to the owner/shareholder (which has better tax treatment then ordinary income); a promissory note-loan is not liquidation but possibly relevant in planning or use of capital; and Fortress can provide support on overall liquidation – or estate planning approaches.

  • Contemplate a short-term impact (penalties and ordinary gain for tax purposes)
  • Annuity or recurring payments back to the owner and how that manifests in terms of cash flow/tax impacts.
  • Keep in mind that a Captive is a C corporation. Planning for the liquidation of a Captive is no different from planning for liquidation of other C corporations. The liquidation strategies can include (without limitation) charitable remainder trust, qualified opportunity zone, etc.
Minimum threshold to keep in captive at a given time

Insurance Manager requires 200K of reserve capital to be retained on the balance sheet of the captive itself as the minimum threshold; in the beginning years, the captive can choose to contribute 20% annually of premium as non-deductible equity to build to the 200K minimum in the early years versus posting 200K day 1 as non-deductible equity to capitalize the company.

What are general best practices for Captive?
  • The Captive is a licensed insurance company. As such, it must have adequate capital and reserves for the risks it insures.
  • Captives can insure only genuine business risks.
  • Risks must be underwritten.
  • Appropriate premiums must be established by qualified insurance actuaries per industry guidelines and professional judgment.
  • Risks insured by the Captive cannot duplicate commercial insurance coverages.
  • Risk sharing must occur with other businesses. This arrangement is sometimes referred to as the insurance “Pool.”
  • Risk shifting must be present. Risk must be shifted away from the insured business to the Pool where it is shared by other insured businesses.
  • A claims process must be established and followed. Claims cannot be handled on an “ad hoc” basis.
  • Dividends must be reported in shareholders’ income (1099 issued from Captive).
  • Loans must be evidenced by a promissory, bear an appropriate rate of interest and must be performing.
  • The Captive files a tax return each year and pays its own tax on investment income.
  • Risks, premiums and reserves of the Captive should be reviewed at least annually and whenever warranted by changes of the insured operating company.
What kind of investments can I have in the captive?

General answer is broad marketable securities (stocks, bonds, etfs, etc.). Year 1 more liquidity is needed to be addressed to ensure potential claims; year 2 onward (after premium has been earned and is then on the balance sheet in reserves) there is a little more latitude for some less liquid assets, private equity, real estate, etc. Overall, it is an insurance company so the balance sheet should reflect the ability to pay claims but investment options are generally broad and flexible. Premiums are generally earned over a 12-month period and must remain liquid during that time. Earned premiums are booked at net income and become a part of retained earnings. It’s important to keep in mind that the Captive is an insurance company. As such, it must retain adequate liquidity to participate in the claims-sharing process of the Pool. The Captive may also need to pay a share of a claim of the insured operating company.

We advise that you work with your fiduciary who will be managing the captive assets on a periodic basis, ensuring that the captive’s assets are within the appropriate minimum, threshold as well as striking the right balance of risk/return for you and your business.

What’s-in-it for captive insurance companies under the current administration’s tax plan?

Over the years, the IRS has amended its approached to captives that instead of assailing them, they have formulated some “safe harbor” laws to keep them regulated while keeping the right to assess their arrangements based on their each entity’s facts and circumstances.

However, based on the current administration’s proposed tax plan, captive insurance companies’ tax incentives may be modified or could possibly become non-existent. The proposal is to raise the individual top marginal tax rate starting January 1, 2022 to 39.6% for individuals with taxable income beyond $509,300. For taxpayers with more than $1 million in adjusted gross income, the long-term capital gains and qualified dividend tax rate would be raised to 39.6% (adding the 3.8% net investment income tax).

We are yet sure what the concluding preferential tax rates will be, but companies and dealerships should be prepared for the possible tax changes. Here are some steps that can be considered:

– Hasten the allocations from the reinsurance company prior to December 31, 2021
– Terminate the existing reinsurance company
– Postpone distributions until the next change in administration (with a possibility of reduced tax rates)


You are a good candidate for captive insurance if:

– Your company is paying high insurance premiums with low and consistent claim numbers.
– Your company has a steady cash flow.
– Your company has a manageable and predictable risk portfolio and you have good risk management practices and procedures.
– You need to consult with a Credo Advisor if:
– You think your company has poor risk management practices and procedures.
– You are experiencing any or all of the following:
– high loss ratios
– short-term outlook or price driven
– financially less strong
– highly volatile or catastrophic exposures without the support of stable lines
– too small to accept the risk of loss 



 Our team at Credo ensures that our customers can easily deal with the intricacies of executing and operating a captive program.  Our tax advisors are experienced in advising clients on how to set up a captive insurance company, the structuring prospects for a captive, reviewing an existing captive insurance company, and the current tax landscape of captives. We are sure to provide you with confidence and clarity when it comes to global compliance issues. We assist you every step of the way in managing your risk portfolio so you can maximize the ROI from your captive. Contact us for an assessment and guidance!





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