Captives: boon for the middle market; Not that long ago, captive insurance only made sense for huge corporations. New IRS rulings, however, have allowed captives to serve as profit centers for mid-sized companies.

• Author: Molnar, Bruce
• Position: INSURANCE

If you don't have a captive insurance program in place, you may soon be in the minority: insurance industry trends indicate that most businesses will implement a captive insurance program by 2010.

[ILLUSTRATION OMITTED]

Already, more than 10,000 businesses--representing industries ranging from finance to construction--have begun to accumulate vast amounts of pre-tax wealth through captive insurance programs, which use insurance subsidiaries formed to insure or reinsure the risks of its parent company. An estimated 600 captives will be incorporated during 2007, and more than half of those will be formed by middle-market businesses.

Historically, captives have been used by Fortune 500 risk managers as a way to capture commercial insurance premiums. Large multinational companies self-insure the following lines of coverage via a captive: general liability, workers' compensation, employee benefits and property insurance. With favorable claims experience, self-insurance became another profit center for the parent company.

Today, because of recent changes to Internal Revenue Service (IRS) policies, middle-market businesses are also utilizing captives as another profit center.

How Does a Captive Work?

A captive writes policies for the parent company at the owner's discretion. The parent company can determine the policy terms, whether or not to write new or renewable policies and the types of insurance coverage to write, which can vary from year to year. The only business that can file a claim is the parent company. If the owner has years of good claims experiences, the premiums that have been successfully deducted can later be taken as dividends or as liquidated capital at the capital gains tax rate.

For example, consider, Company ABC, a California-based commercial construction business with taxable income of $10 million. It will pay 45 percent in federal and state income taxes, leaving it with 55 percent, or $5.5 million for claims, or for distribution to shareholders. Instead, Company ABC funds $4 million in premiums to its wholly owned captive insurance company. It now has an additional $1.5 million available for expenses, claims or additional distributions to shareholders.

Captive insurance enables business owners to better manage insurance needs, including cost, coverage, service and capacity. Additional benefits include pre-tax wealth accumulation, favorable distribution rules, asset protection, highly efficient estate planning/wealth...