The document provides an introduction to captive insurance, outlining who should form a captive based on risk profile and financial resources, the types of companies that typically benefit from captives, and the benefits such as custom policies, tax advantages, and negotiating leverage. It also describes the key steps to forming a captive including performing a feasibility study, applying to the jurisdiction, and requirements around capital and surplus as well as ongoing requirements like using a domicile manager.

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