1. An Introduction to Captive
Insurance
F. Hale Stewart, JD, LLM, CTEP, CWM,
CAM
Author of the book U.S. Captive
Insurance Law
Captiveinsuranceinfo.com
832-330-4101

2. Who Should Form A Captive?
 A company that has an above-average
risk profile.
 A company or individual with the
financial resources to contribute to the
captive.
 Finally, a company should have a good
combination of income and risk
◦ Ideally, a company should have $3 million in
gross revenue
◦ But a company that has $1-$3 million may
have enough risk to warrant looking at a
captive.
◦ Please call if you have questions

3. What Companies Are More
Likely to Benefit From a
Captive
 Doctors and other professionals
 Manufacturers
 Exporters and Importers
 Dry Cleaning
 Construction Related Professions
◦ Contractors
◦ HVAC
◦ Plumbing
 Oil and Gas
 Hotels, Motels, Restaurants and Inns
 Transportation Companies

4. What Are the Benefits of
Forming A Captive?
 Custom Insurance Policies
 The Beech Case
 Using Individual loss experience in determining insurance
rates
 Gives the insured negotiating leverage with third
party insurers
 Third party insurer insures standard risk
 The captive underwrites specialty risk
 Captives can be used as wealth transfer vehicles
 Small Insurance Companies are Taxed Advantaged
 831(b)

5. What Are the Benefits to
Forming a Captive, con’t?
 Underneath the insurance and risk management purposes of
a captive insurance company is a great tax arbitrage
opportunity.
 In the current year, the insured lowers his taxable income
through the payment of insurance premiums. In forming
the captive, the insured is most likely insuring a large
amount of risk which was previously “self-insured,”
meaning the insured paid for losses out of current
earnings and savings.
 The premiums are placed into a tax-advantaged vehicle –
remember that small insurance companies are taxed on
their current portfolio income rather than their current
earnings.
 When the insured sells his captive shares, the transaction
is taxed as a capital gains transaction rather than as an
ordinary income transaciton.

6. What Are the Steps to Forming
a Captive?
After a company decides to form a captive,
the next step is to perform a feasibility
study, which has three objectives.
 It provides a blueprint for the entire captive
program.
 Second, it aids in compliance.
 Third, the study can aid in selling important
decision-makers within the organization on the
plan.

7. What Are the Steps to Forming
a Captive?
 The jurisdiction where the captive is being
formed must determine if forming the
captive is in the jurisdiction’s best interest.
To do that, they will consider
◦ (i) The character, reputation, financial standing
and purposes of the incorporators;
◦ (ii) The character, reputation, financial
responsibility, insurance experience and
business qualifications of the officers and
directors; and
◦ (iii) Such other aspects as the commissioner
shall deem advisable.

8. What Are the Steps in Forming a
Captive, con’t
 Next, the applicant must make a formal
application to open an insurance company. The
application must typically contain the following
information
 (A) The amount and description of its assets relative to the
risks to be assumed;
 (B) The adequacy of the expertise, experience, and
character of the person or persons who will manage it;
 (C) The overall soundness of its plan of operation;
 (D) The adequacy of the loss-prevention programs of its
parent, member organizations, or industrial insureds, as
applicable; and
 (E) Other factors considered relevant by the commissioner
in ascertaining whether the proposed captive insurance
company will be able to meet its policy obligations
 Finally, there is the issue of original capital and
surplus.

9. Running the Captive
Domicile manager
Legal counsel
Audit
Actuarial Services
Investment manager

10. Shutting Down the Captive
 In most states, one of the following seven reasons
will allow a state regulator to shut down a
captive:
◦ 1. Insolvency or impairment of capital and surplus.
◦ 2. Refusal or failure to submit an annual report … or any
other report or statement required by law or by lawful
order of the director.
◦ 3. Failure to comply with the provisions of its own
articles of incorporation, bylaws or other organizational
document.
◦ 4. Failure to submit to an examination or any legal
obligation related to the examination.
◦ 5. Refusal or failure to pay the cost of an examination.
◦ 6. Use of methods that, although not otherwise
specifically prohibited by law, render its operation
hazardous or its condition unsound with respect to the
public or to its policyholders.
◦ 7. Failure otherwise to comply with the captive statute.

11. The IRS Fought Captive
Insurance For Nearly 30
Years
They used three arguments
The Economic Family
Nexus of Contracts
Assignment of Income
No Court Accepted Any of the
IRS’ arguments

12. Safe Harbor Guidance, Part I
Under Harper, a captive must comply with
a three prong test:
(1) whether the arrangement involves the
existence of “insurance risk”;
(2) whether there was both risk shifting
and risk distribution; and
(3) whether the arrangement was for
“insurance” in its commonly accepted
sense.
The duck test – does the company “walk
and talk” like an insurance company?

13. Safe Harbor Guidance, Part II
 The IRS has issued several Revenue Rulings that
provide further safe harbor guidance
 A captive must derive at least 50% of its
insurance revenue from a non-parent.
◦ Harper lowers this amount to 30%
◦ This is accomplished through reinsurance
 Or, a captive must have at least 12 subsidiaries
in order to have sufficient risk distribution.

14. Private Letter Rulings, or, the
Ultimate Safe Harbor
A Private Letter Ruling (or PLR) is "issued
for a fee upon a taxpayer's request and
describes how the IRS will treat a proposed
transaction for tax purposes."
Private Letter Rulings create certainty – we
know how the IRS will view a specific
transaction

15. The Law Offices of Hale Stewart
 Approved Utah Captive Manager
 Start-up costs are usually between $25,000 - $50,000
 Ongoing fees are usually between $15,000 and $20,000
 These fees do not include reinsurance, risk distribution or
accounting fees