Lance Bradford, Managing Partner of LL Bradford Certified Public Accountants and Consultants in Las Vegas, Nevada, says smaller businesses should brave the challenges of forming and managing a "captive," and reap the same benefits.
To that end LL Bradford has promoted Aaron Dean, an MBA with financial and tax expertise, to handle these wealth management plans and strategies for all of its clients.
"The costs and complexities of properly insuring any business against an ever-growing range of risks can be considerable, but the costs of not being properly insured can be catastrophic," says Dean. "Many businesses, especially smaller businesses, simply buy insurance from high-cost providers or risk operating without some types of insurance coverage because they assume there are no other options.
"But, a well structured, well managed captive insurance company that exclusively insures your business can provide risk protection that is tailored your needs at a substantially reduced cost," says Dean. "It can also deliver some big tax and wealth management benefits."
"Right now, every smaller, profitable, closely held company should consider owning a captive," says Bradford concludes. For years, large corporations have realised significant premium reductions, tax advantages and wealth accumulation opportunities by owning captive insurance companies.
A "pure" captive is a small, private, licensed insurance company that underwrites the risks of the owner's company and/or related business entities. It can provide many products and services normally available through the commercial insurance market, but cannot sell insurance to other businesses or the general public.
A corporation with one or more related business entities establishes and capitalises the captive as a wholly owned subsidiary in a jurisdiction that allows it to operate as a licensed insurer. In order for a captive to be considered a true insurance company, it must 1) accept the risks of the owner and one or more of its related entities, and 2) generate more than 50% of its total revenue by issuing insurance and/or annuity policies.
The owner identifies which risks the captive will insure. The captive evaluates the risks, writes policies, sets premium and deductible levels and accepts premium payments. The owner and its related entities pay the captive premiums and the captive, like any other insurer, invests the premium payments as a hedge against payouts on future claims. The captive also services and settles any applicable claims filed by the owner or its related entities.
"Forming and managing a captive isn't easy," Bradford says. "It requires a good deal of internal resources, as well as outsourced management expertise. Not only does it have to operate as a bona fide insurance company, it also has to comply with State and Federal regulations just like every major underwriter."
"But, for any company that nets more than USD500,000 in sustainable operating profits and needs to protect underinsured or uninsured assets, the benefits of owning a captive can be immediate and well worth the time and effort," Dean adds.
A captive can effectively mitigate or eliminate many of the toughest insurance problems facing many smaller businesses. Perhaps first and foremost, a captive can remove the temptation to "self-insure" against certain critical risks because appropriate coverage is either unavailable from commercial providers or prohibitively expensive.
A captive only assesses the unique risks of the owner and its related entities, and writes policies to meet these specific needs. It can also offer more flexible risk financing options than a commercial provider. For example, a captive would ideally underwrite "manageable" risks that have a lower probability of occurrence. However, it can also underwrite higher risks and protect itself by purchasing reinsurance at a lower cost than the premium it would charge the owner.
A captive can provide comparable risk management and claims services at a fraction of the cost of a commercial provider. Since it has nowhere near the overhead of a major underwriter, the owner pays significantly lower premiums and can retain more dollars within the company to help improve cash flow or fund capital expenditures.
However, a series of significant tax advantages are the icing on the captive cake. A provision in the IRS Code states that a captive can avoid tax on gross property and casualty premium income of $1.2 million or less and pay tax only on its investment income. The owner can establish multiple "mini captives," if necessary, to ensure that the gross premium income of each does not exceed $1.2 million.
The captive can also issue more than one class of stock. Shareholders can receive "qualifying" dividends that are eligible for preferential tax rates. Preferred stock distributed to officers and other key employees of the owner company could be redeemed upon their retirement. In this case, the capital gains tax on these shares would be lower than the tax on any other form of deferred compensation.
However, if the shareholders are members of the owner's family, or are trusts having family members as beneficiaries, all of the captive's income inures to their benefit. Because these transactions take place in the ordinary course of business, this transfer of wealth within a family incurs no gift or estate taxes.
"Beyond all of its essential insurance benefits, a captive can also be an excellent wealth accumulation vehicle," states Bradford. "It's a major reason why LL Bradford regards owning a captive as a critical component of a comprehensive insurance and estate planning strategy for many of our smaller clients."