“Captive” insurance companies have been around for years and years, but passage of the North Carolina Captive Insurance Act now means that captive insurance companies can be domiciled in North Carolina. And indeed, the North Carolina Department of Insurance is promoting North Carolina as a “no red tape” state for housing captive insurance companies.
Initially, captive insurance companies were usually formed outside of the United States, often in the Caribbean countries. Slowly but surely, however, various states in the U.S. have adopted captive insurance acts to try and lure premium tax revenues to those states.
North Carolina has become the latest of a growing number of states permitting captive insurance companies in order to attract insurance premium taxes. In addition, a number of consulting firms are actively marketing captive insurance programs to closely-held business owners in North Carolina.
A “captive insurance company” is created by one or more business owners to fund the insurance risks associated with their related businesses. For example, the owner of a profitable manufacturing business might create a captive insurance company, to be owned by Generation 2 (or Generation 3), to serve as an insurance fund to protect against certain uninsured or underinsured risks of the manufacturing business. The manufacturing business can deduct, for income tax purposes, the premiums paid by the operating company to the “captive” insurance company.
Under the federal tax laws, the operating company can deduct up to $1.2 Million of premiums paid to a captive each year. The captive itself, however, does not pay income tax on the premiums it receives. Instead, the captive only pays income tax on the investment income and gains it earns on its investment assets.
So, a captive insurance company can serve as another profit center for the family conglomeration of businesses, and can be a very tax efficient way to transfer wealth to lower generations. We understand that “captives” work best for closely-held businesses with revenues of at least $10 Million to $15 Million who are able to invest $500,000 to $1 Million in premiums on an annual basis. However, the operating business must have a bona-fide and legitimate self-insured risk. That is, the arrangement only stands muster with the IRS if the owner’s primary motivation is to manage risk and not just to save taxes.
So, if you haven’t already heard of captive insurance companies, you will soon. If you decide to investigate this technique further, please be sure to fully vet your consulting firm.