What a Captive Insurance Company is
Captive insurance companies are wholly owned subsidiary companies that offer risk-mitigation solutions for its precursor or a related group of companies. Captive insurance companies can form when the parent company can’t locate an outside organization to provide coverage against certain business dangers; when the premiums to the captive insurer produce tax savings; or if the insurance offered is more affordable or provides enhanced coverage for the parent company’s needs.
Explaining These Types of Insurance Companies
This type of insurance company is in the category of corporate “self-insurance.” Although there exist financial advantages when it comes to using a new entity to offer insurance services, parent firms need to think about the relative overhead and administrative expenses—like extra personnel. There are also intricate compliance problems to think about. Larger companies normally make captive insurance companies themselves because of this.
The tax idea for captive insurance companies is simple. The parent organization offers insurance premiums to its captive insurance company and looks to take these premiums out as deductions in its home country— typically a high-tax jurisdiction.
A parent company would place the captive insurance firm in tax havens—like the Cayman Islands and Bermuda to bypass adverse tax entanglements. Several states in the United States now permit the formation of captive insurance companies. The benefit of lenient tax assessments is a welcomed advantage for the parent company.
When a parent company obtains a tax break from the formation of this kind of insurance company—depending on the type of insurance—the firm profits. The Internal Revenue Service (IRS) expects risk shifting and risk distribution to be available if the company wants to fall under the classification of “insurance.” The IRS has stated publicly that it plans on taking action against insurance companies thought to be evading taxes.