Are you having trouble finding the right insurance for your organization? Whether you operate in a niche area or have complex risks, it can be difficult to locate a mutual insurance carrier that provides your business with customized insurance. If you find your business in this position, it might be time to consider captive insurance.
In this article, we will outline the basics of micro captive 831(b) businesses, how this form of insurance differs from mutual insurance, and the pros and cons of establishing a captive insurance plan. If you have any questions, don’t hesitate to reach out to one of our team members to schedule a consultation.
What is a Micro Captive 831(b)?
Under Internal Revenue Code 831(b), businesses can create captive insurance companies to protect against insurance risks and receive tax benefits. Qualifying micro captive businesses can elect to only pay taxes on their investment income.
There are two types of captives: pure and sponsored. Pure captives are 100% owned by their insureds, while sponsored captives are owned by unrelated third parties. Captive insurers are the company that provides the insurance while insureds are the recipient of the coverage.
The main goal behind micro captive 831(b) plans is to create comprehensive policies that effectively reduce the risks of its owners.
How Does Captive Insurance Differ from Mutual Insurance?
Captive insurance is similar to mutual insurance in that one of the primary purposes is to provide insurance coverage; however, there are some key differences to be aware of. First, insureds put their own capital at risk when creating a micro-captive under IRC 831(b). Companies that purchase captive insurance are willing to invest in their own resources, which leads to greater control and profit opportunities.
Next, micro-captive companies work outside of the commercial insurance marketplace and are only looking to achieve the financing objectives of the parent organization. This means that the captive insurer doesn’t have access to state guarantee funds and doesn’t have the same protections as mutual insurers. Micro-captive companies don’t usually insure companies outside of the controlled group.
Another key difference is ownership status and level of control. Although policyholders technically control and own their mutual insurance companies, their ownership ceases once the policy expires, and they have no real control over the assets or day-to-day decisions.
On the contrary, captive insurance provides your organization with active participation in running the company and the ability to craft personalized policies based on your organization’s needs.
What are the Pros of 831(b) Plans?
When your business is having difficulty finding the right insurance products to meet its needs, it might be time to consider captive insurance. Here are additional benefits of establishing a 831(b) plan:
Effective Risk Reduction
Obtaining comprehensive commercial insurance policies is often expensive and doesn’t exactly fit your organization’s needs. Captive insurers can piece together customized policies for difficult risks, as long as both the insurer and insured follow underwriting and regulatory guidelines.
When you have insurance that is designed to reduce risk in your organization, you can operate with fewer restrictions, knowing you have coverage. Maybe you decide to pursue that expansion project or launch a new product. Whatever the case, captive insurance can reduce risks, making it feasible to reach your strategic and operational objectives.
Increased Availability
Pricing and insurer availability can be difficult to maintain with traditional commercial insurers. With a captive insurer, you can leverage pricing stability. As more capital is accumulated, it becomes easier for your captive insurer to safeguard your business against risks and changes in the commercial insurance market.
Additionally, you have a lower likelihood of policies lapsing or lagging in coverage with a captive insurer. You can guarantee that your business will always have access to the available coverage.
Improved Cash Flow
A micro-captive 831(b) plan can help with your cash flow, regardless of if a profit or loss is generated. Losses by your captive insurer can offset profits in your main business for tax purposes, while profits add to your cash flow.
Additionally, any gains or income generated from invested premiums indirectly go to your business. Even if your captive insurer takes a conservative approach to investments, the income can be substantial based on the level of assets held.
Captive insurers also have fewer operating expenses compared to commercial insurers. This helps preserve the bottom line without having to pay for unrelated expenses. Typically, the expense ratio for captive insurers is around 15% to 30% of premium costs, saving your business thousands in expenses alone.
What are the Cons of 831(b) Plans?
Despite the mounting list of benefits, there are some cons associated with micro-captive 831(b) plans.
Close IRS Scrutiny
The first con is high IRS scrutiny. Because of the tax advantages under Section 831(b), the IRS closely monitors plans to detect abusive micro-captive structures. The IRS deems a micro-captive abusive if the plan structure lacks attributes of genuine insurance.
Working with an 831(b) plan administrator can help thwart unwarranted IRS notices and audits. You want to be sure your business is properly satisfying underwriting requirements and following all applicable regulations.
Personal Risk
The next disadvantage is personal risk. Owners generally place their own capital into the micro-captive. If the company does need to utilize funds for a claim, your capital could be lost. Having effective risk management procedures in place to reduce the likelihood of claims can help safeguard your personal capital.
High Start costs
If you plan on forming your own captive insurance company, there can be expensive startup costs. Capitalization requirements, formation fees, legal fees, and accountant fees can all increase the upfront costs. Joining an established captive group can help mitigate some of these upfront costs. There are also ongoing costs associated with maintaining your captive insurance plan.
Getting Started
Does it sound like captive insurance is right for your business? There are dozens of considerations you need to evaluate before moving forward with your captive insurance plan, which is why it’s best to consult with an expert.
At SRA 831(b), we can help you navigate the captive insurance realm, including pinpointing prevalent risks, ensuring compliance with the IRS, and finding optimal insured levels. Reach out to a team member today to schedule your consultation.
Disclaimer: The information provided in this blog post is intended for general informational purposes only. It should not be considered a substitute for professional financial advice. If you require specific financial advice, please consult with a licensed financial advisor. While we endeavor to provide accurate and current content, we do not guarantee the accuracy, completeness, or compliance of any information mentioned in this blog post. We are not liable for any decisions you make based on the information provided in this blog post. We strongly encourage you to conduct your own research before making any financial decisions.