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Three things business owners should know about owning their own insurance company

Many clients, whether publicly-traded or closely-held, have experienced problems with the commercial insurance markets and have set up their own “captive” insurance companies. The economics have developed so that smaller companies with significant risks can profitably use a captive.

1) Businesses of many sizes can own their own “captive” insurance companies to address commercial market issues

Have you experienced any of these issues with the commercial insurance market:

§ inability to obtain needed coverage,

§ coverage only available at an excessive price,

§ widely fluctuating premiums,

§ dissatisfaction with claims handling,

§ access to the reinsurance market, or

§ desire to capture the insurance company’s profit?

To address these and other issues, many clients have formed “captive” insurance companies. Sometimes one parent company or entrepreneur owns both the insurance company and the operating companies (a single parent captive); sometimes unrelated companies in the same industry form a “group captive” to cover hard to insure risks. Some business owners choose to own or “rent” a portion (cell) of another’s insurance company.

It may seem surprising that closely-held business owners can profitably operate a captive, but, the use of captive insurance has risen dramatically in recent years for several reasons including:

§ Captive insurance has been accepted into the “mainstream” of insurance alternatives.

§ Captives are more affordable because of the growing infrastructure of service providers available to assist in establishing and operating captives.

§ A substantially improved tax climate.

§ Many jurisdictions are seeking captives.

§ Many businesses have concerns about the commercial insurance market, particularly post-9/11.

2) When are businesses good candidates for captive insurance

A company should only establish a captive insurance company, if there is a valid non-tax business reason and comfort with assuming the risk of loss and absorbing the volatility of such losses.

A company should view captive insurance as a long-term commitment. Our experience is that companies with high insurance premiums and good loss experience are prime candidates, including those in the trucking, manufacturing and construction industries.

The first step in exploring a captive is to commission a feasibility study to determine if the benefits of a captive insurance company outweigh

the additional costs. Among other things, the study will identify potential domiciles, projected costs, potential coverages and premiums, volatility of the risks, potential benefits, necessary capitalization and the financial consequences of operation.

Captives with no more than $1.2 million of premium income do not pay tax on their underwriting income; only their investment income is taxed.

A complete tax exemption is available (but very hard to obtain) for certain smaller captives. From a purely tax perspective, longer-tailed coverages (e.g., workers’ compensation and liability) are more valuable than shorter-tailed (e.g., fire and wind storm). Some companies insure their deductible.

Greenebaum has long-term experience with the many tax issues involved; for instance, we represented the taxpayers in two of the five favorable captive insurance tax cases at the Federal Court of Appeals level.

3) Kentucky is a great jurisdiction in which to form your captive

Initially, most captives were formed offshore — such as in Bermuda or the Cayman Islands. Vermont is the most established U.S. jurisdiction among the 29 states that now have captive legislation.

Kentucky recently modernized its captive law. Kentucky has recently become extremely active and has a very user-friendly approach to any potential captive with a strong financial underpinning. As long as the finances are strong, Kentucky will work with a potential captive to help accomplish its goals. Further, a captive pays a relatively low state premium tax and no local premium tax, which can be an extremely valuable benefit.

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