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Captive Insurance Companies
(CICs)
By: Roccy DeFrancesco, JD, CWPP, CAPP, MMBFounder: The Wealth Preservation InstituteCo-Founder: The Asset Protection Society
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Introduction
• Captive Insurance Companies have been around for many years.
• There are approximately 5,000 captives in the world.
• Over 50% of the "Fortune 500" companies have captives.
• CIC are not exotic or complicated; they are just not well known to most people.
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What is a Captive?
• It is just what you would think it is….
“An insurance company owned and
controlled by its policyholders”
• With a CIC, the policy holder is typically a single company, person, family or trust.
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Type of Captives
• Single parent*• Group/association/RRG• Rental captives, Segregated protected cell• Common Characteristics.
– A participation of a risk sharing partner, or traditional insurer.
• *The most prevalent structure.
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Typical Ownership Structure
Business 1Captive
InsuranceCompany
Business 2
Business Owner
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Why are Captives Formed?
• 1) Retain risk – This allows the owners to keep profits when insurance
claims are low.
• 2) Reduce income taxes
• 3) Build wealth
• 4) Reduce estate taxes
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Structuring a Captive
• To make a CIC financially viable, you need to commit to sufficiently large premiums $250,000+ annually for an 831(b).
• The CIC must be funded properly to be able to pay claims.
• You must recognize that a captive is a business separate and apart from your other business.– Which means you must pay attention to running the
captive or like any business it will not perform well.
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Costs to setup and run
• Single parent captives setup fees range from $50,000 to $250,000.
• On an annual basis, the costs to keep a captive “compliant” are between $15,000-$35,000 a year.
• While this seems expensive, for the “right” business owner, these fees are insignificant compared to the value.
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Domicile Selection
• You can choose between 24+ States permitting captive formation; or offshore, outside the United States (i.e. Bermuda, Cayman Islands, British Virgin Islands leading the way).
• A principal difference between onshore and offshore is potential ease of regulation and capitalization.
• U.S. domiciled companies should NOT use an offshore captive to write insurance in the U.S. and think they will avoid U.S. income taxes.
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Income tax reduction
• Small Insurance Companies - Insurance companies with annual premium income of less than $1.2 million can elect to be taxed only on investment income.
• Premium income is tax free. However, investment income earned on the funds held inside the insurance company is taxable at ordinary C corporation rates*. (Internal Revenue Code section 831(b))
• *This can be mitigated with different type of wealth building tools.
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“Real” Purpose of a Captive
• Most small CICs are formed to insure remote risks that are not likely to have claims.
• Why? • To build wealth in a tax favorable manner in a CIC.
– The business takes a 100% deduction for the premium– The CIC receives it tax-free– If structured properly much of the money can grow tax-free– Upon terminating the CIC, the money goes to the owners after
paying capital gains taxes (not ordinary income taxes).
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Establishing Premiums
• You will hire an actuary to help you determine what kind of coverages and how much of each your businesses will be able to purchase.
• In the real world, you will tell the actuary how much in new insurance premiums your business can afford to deduct.
• Then the actuary will find the types of coverages in your industry to meet this need (if possible).
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Typical non-traditional coverges
• Loss of License insurance• Business overhead expense (primary or excess)• Excess Professional Liability Legal / Claim Expense• Excess Professional Liability Loss Reimbursement • Disability Expense Reimbursement Protection• Key Supplier Loss Expense Reimbursement• Key Customer Loss Expense Reimbursement• Product Recall Loss Expense Reimbursement• Market/COGS Fluctuation Loss Expense Reimbursement• Health Insurance Difference in Conditions Expense Reimbursement• International Travel Accident• International Kidnap/Ransom Investigation Expense• Tax Audit Defense Legal Expense Reimbursement• Criminal Defense Legal Expense Reimbursement• Regulatory Investigation Defense Legal Expense Reimbursement• Injunctive Relief Defense Legal Expense Reimbursement• Bankruptcy Legal Expense Reimbursement• Currency Risk Loss Expense Reimbursement• Research and Development Expense Overrun Reimbursement
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Example of an 831(b)
• Sam (a real estate investor and business owner) sets up a CIC.
• Sam raises the deductible on his current insurance policies and insures the new higher deductible with his CIC. His traditional premiums are lowered by $50,000.
• With the CIC in place, Sam’s companies buy new insurance coverages including business interruption, terrorism, employment practices and fire damage to his tracts of timber.
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Continued
• Sam’s new premium to the CIC is $450,000 (which his businesses can write off).
• The CIC does not pay income tax on the premium.• If Sam is in the 40% tax bracket, he just saved
$180,000 in income taxes, and• Sam will build significant tax-favorable wealth by
paying $450,000 every year for X years into his CIC.
• When in retirement, he can close down his CIC and receive the money by paying capital gains taxes.
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Estate planning
• CICs can be one of the best estate planning tools if you have a profitable business and an estate tax problem.
• Most successful business owners with estate tax problems gripe when they take money home and pay tax on it and then have to figure out a way to get it out of their estate for estate tax purposes.
• With a CIC you can move money out of an estate literally overnight without income, gift, or estate tax worries.
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Estate Planning
• If an irrevocable trust (IT) for the benefit of his of Sam’s daughter owned the CIC, Sam would have shifted significant wealth to the daughter income and estate tax free.
• In this example, the total potential tax savings for paying $450,000 into a captive insurance company could be as much as $400,500. The breakdown is as follows:
Income tax savings $180,000.00
Estate tax savings 220,500.00
Total $400,500.00
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For estate planning
Irrevocable Trust (IT)
CIC
• Sam gifts “Seed” money to the IT.• IT forms CIC.• CIC Sells insurance to Sam’s company.• Company makes tax-deductible premium payments.• CIC is owned by IT therefore the tax-deductible premiums
are now out of Sam’s estate and the business now has additional insurance coverage.
Sam
Gifts Seed Money
Company
Tax-DeductiblePremiums
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Purchasing Life Insurance (LI)
• People with estate tax problems have a significant need for life insurance to pay estate taxes.
• Gifting to an ILIT is typically.• LI on Sam’s life can be a nice secure wealth
building tool for a CIC.• And since the CIC can be owned by an IT, when
Sam dies, the death benefit would pass through the IT income and estate tax free.
• This structure allows you to pay for your needed life insurance with tax deductible dollars and without gift tax headaches.
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Life insurance
Irrevocable Trust
CIC
• The CIC manager has a duty to invest the money in a prudent manner.
• A High Cash Value policy is a terrific idea because it 1) mitigates investment risk (downside protection), 2) would provide a financial windfall that would really fund the CIC upon a death, 3) allows money to grow in an 831(b) captive tax free.
Client
Gifts Seed Money
Company
Tax-DeductiblePremiums
Life insurance policy
CIC buys high cash value life insurance policy
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Benefits of a CIC
• Income tax reduction
• Wealth building
• Retirement planning
• Estate planning
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Summary
• CICs are not for everyone.
• However, if you are a medium to small business owner, a CIC can be one of the most powerful wealth building and estate planning tools at your disposal.
• The key is to work with a team of advisors who knows how to set them up in a compliant and client first manner.