While many midsize businesses are now enjoying the same advantages Fortune 1000 companies have found in maintaining captive domiciles, a captive is not an appropriate self-insurance tool for every company.

Only a careful examination of financial, tax and state regulatory factors will determine whether—and how—a company should form a captive, experts say.

Those considerations are as critical for midsize companies with captives eligible for Section 831(b) treatment under the U.S. tax code as they are for larger companies. (Under Section 831(b), an insurer that generates $1.2 million or less of annual premium volume is taxed only on its investment income, not its underwriting profit.)

According to captive managers, tax experts and regulators, the prospective owner of a captive eligible for 831(b) treatment needs to meet these criteria:

Must be profitable. Besides annual premiums and initial capital and surplus requirements of between $100,000 and $250,000, annual operational expenses range from $40,000 to $85,000, depending on the captive manager and type of captive structure chosen.
Typically generate between $20 million and $300 million in annual revenue. Those companies typically have enough risk to make a captive cost-effective but not so much risk that their premiums would exceed $1.2 million.
Have identifiable risks to insure but cannot find either any commercial coverage or affordable insurance.
Is psychologically capable of absorbing a loss at any time, including the day the captive opens.
Has adequate risk distribution. The Internal Revenue Service states that if a captive covers a dozen insureds, such as its parent company's subsidiaries, and each insured accounts for 5-15 percent of the captive's premium volume, then the IRS automatically will determine risk distribution is adequate. The alternative risk-distribution safe harbor is if unrelated third-party business accounts for 50 percent or more of the captive's premium.
Must choose a captive domicile carefully. Some regulators do not like certain risks or certain sizes of captives. Some regulators have greater experience than others in regulating smaller insurers. Others are highly attuned to a certain risk, because many businesses located within their domicile face the same risk.

Special Reports /

Seeking 831(b) Treatment? You&rsquo;d Better Meet These Requirements

Related Stories

Recommended For You

Seeking 831(b) Treatment? You’d Better Meet These Requirements