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  • 1. Captive Insurance Companies (CICs) By: Roccy DeFrancesco, JD, CWPP, CAPP, MMB Founder: The Wealth Preservation Institute Co-Founder: The Asset Protection Society
  • 2. Introduction
    • Captive Insurance Companies have been around for many years.
    • There are approximately 5,000 captives in the world.
    • Over 50% of the "Fortune 500" companies have captives.
    • CIC are not exotic or complicated; they are just not well known to most people.
  • 3. What is a Captive?
    • It is just what you would think it is….
      • “ An insurance company owned and
      • controlled by its policyholders ”
    • With a CIC, the policy holder is typically a single company, person, family or trust.
  • 4. Type of Captives
    • Single parent*
    • Group/association/RRG
    • Rental captives, Segregated protected cell
    • Common Characteristics.
      • A participation of a risk sharing partner, or traditional insurer.
    • *The most prevalent structure.
  • 5. Typical Ownership Structure Business 1 Captive Insurance Company Business 2 Business Owner
  • 6. Why are Captives Formed?
    • 1) Retain risk
      • This allows the owners to keep profits when insurance claims are low.
    • 2) Reduce income taxes
    • 3) Build wealth
    • 4) Reduce estate taxes
  • 7. Structuring a Captive
    • To make a CIC financially viable, you need to commit to sufficiently large premiums $250,000+ annually for an 831(b).
    • The CIC must be funded properly to be able to pay claims.
    • You must recognize that a captive is a business separate and apart from your other business.
      • Which means you must pay attention to running the captive or like any business it will not perform well.
  • 8. Costs to setup and run
    • Single parent captives setup fees range from $50,000 to $250,000.
    • On an annual basis, the costs to keep a captive “compliant” are between $15,000-$35,000 a year.
    • While this seems expensive, for the “right” business owner, these fees are insignificant compared to the value.
  • 9. Domicile Selection
    • You can choose between 24+ States permitting captive formation; or offshore, outside the United States (i.e. Bermuda, Cayman Islands, British Virgin Islands leading the way).
    • A principal difference between onshore and offshore is potential ease of regulation and capitalization .
    • U.S. domiciled companies should NOT use an offshore captive to write insurance in the U.S. and think they will avoid U.S. income taxes .
  • 10. Income tax reduction
    • Small Insurance Companies - Insurance companies with annual premium income of less than $1.2 million can elect to be taxed only on investment income.
    • Premium income is tax free . However, investment income earned on the funds held inside the insurance company is taxable at ordinary C corporation rates*. (Internal Revenue Code section 831(b))
    • *This can be mitigated with different type of wealth building tools.
  • 11. “ Real” Purpose of a Captive
    • Most small CICs are formed to insure remote risks that are not likely to have claims.
    • Why?
    • To build wealth in a tax favorable manner in a CIC.
      • The business takes a 100% deduction for the premium
      • The CIC receives it tax-free
      • If structured properly much of the money can grow tax-free
      • Upon terminating the CIC, the money goes to the owners after paying capital gains taxes (not ordinary income taxes).
  • 12. Establishing Premiums
    • You will hire an actuary to help you determine what kind of coverages and how much of each your businesses will be able to purchase.
    • In the real world, you will tell the actuary how much in new insurance premiums your business can afford to deduct.
    • Then the actuary will find the types of coverages in your industry to meet this need (if possible).
  • 13. Typical non-traditional coverges
    • Loss of License insurance
    • Business overhead expense (primary or excess)
    • Excess Professional Liability Legal / Claim Expense
    • Excess Professional Liability Loss Reimbursement
    • Disability Expense Reimbursement Protection
    • Key Supplier Loss Expense Reimbursement
    • Key Customer Loss Expense Reimbursement
    • Product Recall Loss Expense Reimbursement
    • Market/COGS Fluctuation Loss Expense Reimbursement
    • Health Insurance Difference in Conditions Expense Reimbursement
    • International Travel Accident
    • International Kidnap/Ransom Investigation Expense
    • Tax Audit Defense Legal Expense Reimbursement
    • Criminal Defense Legal Expense Reimbursement
    • Regulatory Investigation Defense Legal Expense Reimbursement
    • Injunctive Relief Defense Legal Expense Reimbursement
    • Bankruptcy Legal Expense Reimbursement
    • Currency Risk Loss Expense Reimbursement
    • Research and Development Expense Overrun Reimbursement
  • 14. Example of an 831(b)
    • Sam (a real estate investor and business owner) sets up a CIC.
    • Sam raises the deductible on his current insurance policies and insures the new higher deductible with his CIC. His traditional premiums are lowered by $50,000.
    • With the CIC in place, Sam’s companies buy new insurance coverages including business interruption, terrorism, employment practices and fire damage to his tracts of timber.
  • 15. Continued
    • Sam’s new premium to the CIC is $450,000 (which his businesses can write off).
    • The CIC does not pay income tax on the premium.
    • If Sam is in the 40% tax bracket, he just saved $180,000 in income taxes , and
    • Sam will build significant tax-favorable wealth by paying $450,000 every year for X years into his CIC.
    • When in retirement, he can close down his CIC and receive the money by paying capital gains taxes.
  • 16. Estate planning
    • CICs can be one of the best estate planning tools if you have a profitable business and an estate tax problem.
    • Most successful business owners with estate tax problems gripe when they take money home and pay tax on it and then have to figure out a way to get it out of their estate for estate tax purposes.
    • With a CIC you can move money out of an estate literally overnight without income, gift, or estate tax worries.
  • 17. Estate Planning
    • If an irrevocable trust (IT) for the benefit of his of Sam’s daughter owned the CIC , Sam would have shifted significant wealth to the daughter income and estate tax free .
    • In this example, the total potential tax savings for paying $450,000 into a captive insurance company could be as much as $400,500. The breakdown is as follows:
    Income tax savings $180,000.00 Estate tax savings 220,500.00 Total $400,500.00
  • 18. For estate planning
    • Sam gifts “Seed” money to the IT.
    • IT forms CIC.
    • CIC Sells insurance to Sam’s company.
    • Company makes tax-deductible premium payments.
    • CIC is owned by IT therefore the tax-deductible premiums are now out of Sam’s estate and the business now has additional insurance coverage.
    Irrevocable Trust (IT) CIC Sam Gifts Seed Money Company Tax-Deductible Premiums
  • 19. Purchasing Life Insurance (LI)
    • People with estate tax problems have a significant need for life insurance to pay estate taxes .
    • Gifting to an ILIT is typically.
    • LI on Sam’s life can be a nice secure wealth building tool for a CIC.
    • And since the CIC can be owned by an IT, when Sam dies, the death benefit would pass through the IT income and estate tax free .
    • This structure allows you to pay for your needed life insurance with tax deductible dollars and without gift tax headaches .
  • 20. Life insurance
    • The CIC manager has a duty to invest the money in a prudent manner.
    • A High Cash Value policy is a terrific idea because it 1) mitigates investment risk (downside protection), 2) would provide a financial windfall that would really fund the CIC upon a death, 3) allows money to grow in an 831(b) captive tax free.
    Irrevocable Trust CIC Client Gifts Seed Money Company Tax-Deductible Premiums Life insurance policy CIC buys high cash value life insurance policy
  • 21. Benefits of a CIC
    • Income tax reduction
    • Wealth building
    • Retirement planning
    • Estate planning
  • 22. Summary
    • CICs are not for everyone.
    • However, if you are a medium to small business owner, a CIC can be one of the most powerful wealth building and estate planning tools at your disposal.
    • The key is to work with a team of advisors who knows how to set them up in a compliant and client first manner.