Captive Insurance, Part I: What is a Captive Insurance Company?

Captive insurance companies were originally established to help businesses cover risks otherwise difficult to secure. They have expanded to include nearly every type of insurance.

To protect themselves from certain risks, many businesses have formed subsidiary companies that provide them with insurance and risk-management services. Captive insurance companies are a form of corporate “self-insurance” and offer many benefits for the companies (or group of companies) that own them.

The origins of self-insurance

In the 1600s, Edward Lloyd opened a coffee house in London that attracted shipowners, captains, and merchants. Lloyd began publishing intelligence on ships and their cargo, and on the foreign events that affected them. Shipowners in England then began doing something that Italy’s seaport villagers had apparently started – recording their names, shipments, and the value of their cargo, and making risk sharing arrangements. Other industries followed suit, and by the height of the industrial age, shared risk arrangements were flourishing.

Incorporating private insurance in the U.S.

The concept of establishing companies for the purpose of providing insurance coverage was the brainchild of Frederic M. Reiss. In the 1950s, Reiss, a U.S. fire protection engineer, worked with companies that engaged in mining activities that were difficult or impossible to insure in traditional markets. He began to incorporate insurance subsidiaries that wrote insurance exclusively for the parent company’s captive mines (these are mines in which the coal or minerals produced are used exclusively by the company that mines them). Reiss began to use the term “captive insurance” for all his clients, and the name stuck.

Over the next few decades, hundreds of captive insurance companies were established, nearly all of them in foreign countries. There were roughly 1,000 captives in the late 1980s. In 1981, Vermont enacted the first captive insurance legislation in the U.S., and many other states followed suit.

Captive insurance in the 21st century

The captive insurance industry took a huge leap when President Obama’s Affordable Care Act imposed substantial fines and penalties on employers of 50 or more full-time employees who did not provide their workers with coverage for their health care needs. A large number of small- and mid-size businesses began taking advantage of the significant tax benefits and lower premiums that were available through captive insurance companies. These captives helped them to meet their company’s health insurance, workers’ compensation, general liability, and other insurance requirements.

Although The Tax Cuts and Jobs Act of 2017 (TCJA) reduced the tax benefits for captives, it did not eliminate them completely. In addition, for many businesses, captives still offer better and less expensive coverage than traditional insurance, and serve as a valuable risk management and mitigation tool.

Today, there are nearly 3,400 U.S.-licensed captives, out of a total of approximately 6,000 worldwide.

Captive insurance planning and litigation

Steve Moskowitz of Moskowitz, LLP has successfully represented many businesses of all sizes with captive insurance tax planning and litigation, and was interviewed by the New York Times following his success in Tax Court in representing a dentist who insured his practice against acts of terrorism. If you are seeking professional tax planning advice or need aggressive tax litigation representation, contact our San Francisco office today.

In the following posts in this series, we will describe the different types of captive insurance companies, the benefits and risks of captives, and the recent IRS crackdown on captive insurance abuse.