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The following is Part VI of a six-part series of blog postings regarding whether a captive insurance subsidiary or one owned by the owners or affiliates of a company may represent an effective risk management tool that also provides economic benefits. Although there are various types of captive insurance, this posting will focus primarily on single parent/pure captives and how they might provide economic benefits for you or your healthcare company. Part I, Part II, Part III, Part IV and Part V of the blog series are here. This posting provides an overview of certain other considerations to forming a single parent or pure captive.    

Part VI – Costs, Expenses and Other Considerations in Forming a Captive

As any experienced business owner, executive or manager understands, risks, costs and expenses are associated with almost every business opportunity. The opportunities and benefits that may be realized through a single parent captive subsidiary are no different; they, too, are subject to costs and expenses.

  • Costs to Organize and Qualify the Single Parent Captive with the Appropriate Jurisdiction

Apart from the time spent in the initial consideration regarding whether organizing, implementing and operating a captive insurance subsidiary makes sense from a business perspective, once the decision is made to move forward, the company will incur costs, expenses and professional fees. These costs and expenses will include but will not be limited to:

  • professional fees for preparing the feasibility study;
  • fees of the actuary to prepare the report required by the feasibility study;
  • preparation of the documents other than the feasibility study that must be submitted as part of the application to the selected jurisdiction’s captive insurance division; and
  • accounting and legal fees.

Thereafter, unless the parent has experienced insurance executives and staff who can operate the captive, it will incur additional costs and expenses as it pays a “captive manager” to operate and manage the captive insurance subsidiary, prepare the financial statements and make the required annual filings and other filings with the applicable jurisdiction’s insurance regulatory authorities. The parent will also need tax professionals, accounting and some legal assistance to handle issues as they arise.

Although some of the costs, expenses and fees are “one-time only,” and the ongoing ones are not necessarily prohibitive, they must be weighed against the overall insurance benefits, economic savings and profit and earnings potential and other benefits to be garnered by the parent from having a single parent captive insurance company in place. Costs, expenses and professional fees cannot be estimated for the purposes of this posting because of the many and varied factors that drive them, the characteristics of the subsidiaries that will be insured and the industries in which they operate and the experience, quality, skills and fee structures of the professional service firms providing assistance.

  • Captive Insurance Companies are Regulated Entities that Limit the Abilities of their Parents or Owners to Operate them Freely  

As is any insurance company offering the types of insurance that may lawfully be offered by a captive insurance company, captives are regulated entities – regulated by the insurance department or division of the government under which the single parent captive is incorporated, organized and licensed. The role of the insurance regulators is to protect insureds – those persons or entities paying premiums to the insurance company for liability protection.

  • Initial and On-going Regulatory Capital Requirements

Among the chief concerns of insurance regulators is to make certain an insurance company has mandated minimum statutory capital sufficient to pay a portion of the insurance claims that may be submitted to the company by or on behalf of its insureds.

Most states’ statutory mandated initial capital requirements are between $250,000 and $300,000 and of course increase based on the amounts and type of insurance coverage offered to the brother-sister affiliates. Over time, as more types of insurance are offered, as the amount of coverage increases and as the number of insureds increase, the capital requirements increase as well. Of course, as previously noted, profits and earnings of the captive and its earnings on investments can be retained as capital but capital requirements remain a necessary and potentially expensive consideration.

Those considering organizing and operating a captive should realize and factor in to any analysis the fact that money contributed to the captive subsidiary as regulatory capital is not easily freed up while the captive has insurance policies in place.

It should be noted that off-shore jurisdictions that have captive insurance statutes, laws or regulations may have different capital requirements than jurisdictions in the United States. This blog posting is limited to jurisdictions in the United States that have captive insurance statutes.

  • Restrictions on Investments

In some jurisdictions in order to certify availability of liquidity, the insurance regulatory authority may prohibit investment in anything other than low-risk, low-return funds.

  • Alternative Uses of Funds Used as Regulatory Capital

Rather than being tied up in the captive insurance subsidiary as regulatory capital, the parent could instead use those funds for other corporate purposes including capital expenditures and corporate acquisitions for its operating subsidiaries.

  • Dividend and Other Restrictions Imposed on Captive Insurance Subsidiaries

The statutes and regulations of the various jurisdictions also regulate the payment of dividends and distributions to the owners of the captives and they also regulate mergers and asset sales by insurance companies, including captive insurance companies. As a result, boards of captive insurance companies must seek approval from state insurance regulators before dividends and distributions may be made by the captive subsidiary to its parent or owners, and the parents and owners are restricted in connection with the sale of, or corporate changes regarding, the captive. In other words, unlike other unregulated subsidiaries a parent may operate in which dividend payments and distributions from profits and retained earnings are virtually unregulated, payments from a captive to its parent or other owners may not flow freely and are restricted to prior approval by the applicable state insurance regulators.

Conclusion of Six-Part Series 

Single parent captive insurance is a risk management tool that when used primarily to address a company’s liability insurance needs has a number of ancillary but economically beneficial aspects, particularly in the areas of cost containment and even profitability for its corporate parent. It can provide tax advantages for all companies and particularly important tax benefits for smaller companies that can take advantage of the 831(b) election. However, costs and expenses of implementing and operating a captive insurance subsidiary must be factored in.

The starting point for any analysis is whether the company has valid and bona fide insurance needs and economic and business reasons for forming the captive insurance company.  Without those, the company will not pass potential IRS scrutiny and it will not enjoy the benefits and advantages captive insurance can provide. Worse yet, the insureds could lose the deductions they took and the captive insurance company could be required to recognize the premium payments it received as income. The company should also consider its own financial position, the cost it is paying for insurance coverage, whether it is covering the real liability risks the company faces and whether the potential benefits of implementing a captive insurance subsidiary and operating it annually are worth the costs and expenses.

We suggest that in conducting the analysis, management consult with insurance and actuarial professionals, tax accountants and corporate attorneys who are experienced with captive insurance.