The Definitive Guide to Captive Insurance Companies

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Contents

MEET THE AUTHOR.......................................................................................................................viiACKNOWLEDGEMENTS......................................................................................................................ixPREFACE...............................................................................................................................xi1 FUNDAMENTAL PRINCIPLES: WHAT YOU NEED TO KNOW ABOUT CAPTIVE INSURANCE...............................................................12 HOW TO MINIMIZE YOUR ESTATE AND INCOME TAXES WITH CAPTIVE INSURANCE.................................................................233 PUTTING THE CAPTIVE INSURANCE COMPANY TO WORK FOR YOU: HOW TO SET UP A CAPTIVE AND START INSURING YOUR BUSINESS.....................444 WHAT YOU NEED TO KNOW ABOUT MANAGING YOUR CAPTIVE INSURANCE COMPANY: TAX AND REGULATORY REQUIREMENTS................................675 PROTECTING YOUR ASSETS FROM LAWSUITS WITH A CAPTIVE INSURANCE COMPANY...............................................................77APPENDIX: CAPTIVE INSURANCE CASES AND RULINGS.........................................................................................90

Chapter One

Life is filled with risks. Every day, you take risks in your business. Some of these risks are calculated on your part; after all, you must take on these risks in order to make a profit in your business. Other risks may not be so well known to you, or they may not be at the forefront of your mind on a regular basis. As much as you may carry insurance on the truck used to make deliveries in your business, you may not carry similar insurance on the computer used to track your deliveries. There may even be some risks which you know about but which are simply too expensive for you to insure.

Unfortunately, unless you pay an insurance coverage a premium to insure your business against all of these risks, there is no tax benefit to self-insurance. According to the American Institute of Certified Public Accountants (AICPA), most businesses unknowingly self-insure a great part of their risks from daily business activities. This same AICPA report says:

Self-insurance, whether funded out of company reserves or personal after-tax savings is not tax-deductible. To compound the problem, smaller deductibles are expensive and not tax-beneficial.

The solution, according to this AICPA report, is a captive insurance company. Properly structured, "self-insurance through a captive structure can create substantial tax deductions, resulting in tremendous tax savings."

Captive insurance produces material tax savings that help you to save real dollars in your business. Furthermore, captive insurance helps businesses to combat inadequate insurance and excessively high premiums. Yet, most business owners have no idea what captive insurance is, much less how to use it to their advantage.

Captive insurance is a strategy whereby your business purchases insurance coverage from an insurance company that you own and control, i.e., a "captive" insurance company. The premiums paid by your business are tax deductible. Meanwhile, the premiums that your captive collects are tax-free. You read that correctly: The premiums collected by your captive insurance company are tax-free.

Suppose your business pays $1 million in premiums to your captive insurance company every year. Assume further that your combined federal and state income tax rate is 50%. Your business would deduct $1 million from its taxable income, saving you $500,000 each year. Furthermore, that $1 million would be received free of income tax each year inside your captive insurance company. You would pay less in taxes and have more money in the bank.

In this first chapter, I will start you out with a brief history of captive insurance. I will share with you how captive insurance came to evolve into an insurance strategy with tremendous tax savings potential. I will then provide you with an overview of the fundamental legal and tax principles governing captive insurance planning. Finally, I will walk you through an overview of the captive insurance industry so that you have a better understanding of how captive insurance works and how captive insurance companies operate to save their owners money. By the end of this chapter, you should have a basic understanding of what captive insurance is and how it works. More importantly, you should gain some insight into the tremendous tax savings involved by utilizing captive insurance in your business.

A Brief History of Captive Insurance

To better understand how captive insurance works, I would first like to walk you through the origin of captive insurance. It all began with a company in Youngstown, Ohio, called Youngstown Sheet and Tube Company, and their insurance agent, a man by the name of Fred Reiss.

The City of Youngstown and the Steel Industry

Youngstown, Ohio is a rough-and-tumble Rust Belt city sitting on the Mahoning River, almost in a straight line halfway between Cleveland to the northwest and Pittsburgh to the southeast. The city first earned its reputation for holding large coal deposits. With the discovery of iron ore nearby, Youngstown also became a center for steel production.

At the turn of the 20th century, as large national steel companies were making their way into Youngstown, a group of local businessmen founded the Youngstown Sheet and Tube Company. At the same time, labor unions were beginning to make inroads into the Youngstown steel factories.

Youngstown Sheet and Tube gradually earned a reputation for not being easy to intimidate. In 1916, workers at the company went on strike, setting fire to a portion of the city. Afterward, East Youngstown was renamed the City of Campbell in honor of the company's president, who had stood up against the strikers. In 1937, unions banded together and staged what became known as the Little Steel Strike. Youngstown Sheet and Tube joined a group of steel mills that resisted signing an agreement with the strikers.

The Steel Seizure Case

Later, in the early 1950s, labor unions again confronted Youngstown Sheet and Tube, pressing for wage increases amidst the Korean War. As steel mills were under government-imposed price controls, the management at Youngstown Sheet and Tube refused to give into the strikers' demands. When the unions sought help from a labor-friendly White House, President Truman in 1952 issued an executive order seizing Youngstown Sheet and Tube's steel mills. The company's lawyers immediately went to court to fight the presidential decree as unlawful.

The resulting U.S. Supreme Court decision in Youngstown Sheet & Tube Co. v. Sawyer, became known as the "Steel Seizure Case" and was a rebuke of the U.S. President's authority. The Supreme Court ruled that the President could not seize private property without specific authorization in the Constitution or under an act of Congress.

Fred Reiss, the Inventor of Captive Insurance

Around the time that Youngstown Sheet & Tube was fighting President Truman over the right to control its own destiny, Frederic Mylett...