Captive insurance companies: Florida enters the arena.

• Author: Lioce, Domenick R.

In the 2012 legislative session, Florida adopted totally revised captive insurance company legislation to replace the old F.S. [section]628.901, which was relatively barren and simple and rarely used, if at all. The Florida Insurance Code does not apply to captives. (1) The new law became effective July 1, 2012. It is Florida's plan to be competitive with other states, such as Vermont and Delaware, in developing and attracting captive insurance businesses in Florida instead of having them flee the state or country.

A captive insurance company is one formed by a business owner to insure risks of his or her operating business and affiliated companies. The operating business pays a premium to the captive, and the captive insures the risks of the operating business. It must be operated as a real insurance company with reserves, surplus, insurance policies, policyholders, claims, etc. It must be licensed as an insurance company in the venue in which it is formed. The insurance policy and the risks covered therein must be based on professionally tested insurance experts to provide the same business risk/profit used by all insurance companies, and there must be a clear and insurable risk for each policy. (2)

Captive insurance companies have been around for a long time (since 1982 in Florida). For the most part, large national and international public companies utilize captive insurance companies. Lately, however, many smaller businesses are utilizing them for all the benefits that they provide. For federal income tax purposes, the company can provide insurance to itself through an affiliate, and the payments are deductible as with any other insurance company. However, Internal Revenue Code [section]831(b)(2) provides that if net written premiums do not exceed $1.2 million, premium income is not taxable to that company if that company so elects. I.R.C. [section]831(b)(1) provides for tax only on investment income. Coupled with the fact that an entity may be owned by children and other heirs, this is a business venture and is, thus, not a gift for purposes of calculating the lifetime gift tax exclusion utilized by the owner of the business.

The captive provides the means by which a business owner can increase profitability by creating a profit inside the captive and reducing insurance costs in the operating company. The profitability at the insurance company level is higher for companies that have lower claim experience. This lower claim experience can also reduce the costs of insurance at the operating company level by increasing the amount of deductibles or coverages on many insurance policies already in existence at the operating company. The captive then invests the premiums at a profit, and by not having to pay out as many claims as the average insured (the basis upon which the premiums are calculated), additional profits are achieved by both companies.

In addition to these increased revenues, the administrative cost of running a captive is substantially lower than the administrative portion of the premiums charged by insurance companies, including agents' commissions, advertising, costs of compliance, offices, and administrative costs, which is often based on salaries. Some other benefits include increased claims control...