Benefits of Owning a Captive Insurance Company

As explained in an earlier article, a captive insurance company is a subsidiary or affiliate of a closely-held business entity formed to insure or reinsure certain risks of those entities.

The primary reasons hotel owners form a captive insurance company is to effectively manage the uninsured and under-insured risks of their business and to save money on certain types of coverage. But the captive also provides owners a number of ancillary opportunities to achieve business and personal goals.

A hotel owner who has decided to establish a captive insurance company and has qualified as an appropriate candidate, should then ask, "Given my specific circumstances and goals, what is the best way to own the captive"?

Benefits of Ownership by or in Trust for Children and Grandchildren

If the captive is owned directly or indirectly by or in trust for the hotel owner's children or grandchildren, there will be a net wealth transfer without gift, estate, or generation-skipping transfer tax consequences if the captive's reserves are not used to pay claims. Insurance premiums are business expenses, if reasonable -- not gifts. Since the captive's assets would be outside the hotel owner's taxable estate it is an asset that is ideal for a generation-skipping dynasty trust.

Benefits of Ownership by Family Limited Partnerships or LLCs

As with many estate planning structures, the captive insurance company could be owned by a family limited partnership (FLP) or limited liability company (LLC). The FLP or LLC could in turn be owned by various family members or trusts with differing classes of interests and rights. This could provide a continuing ability for the hotel owner to control and invest funds received as distributions from the captive insurance company. Caution must be used in structuring family partnerships and LLCs in light of the IRS' recent aggressive litigation positions in this area.

Benefits of Ownership by Key Management

Another common ownership structure involves creating restricted shares for key management. Since the captive is taxed as a "C corporation" for income tax purposes, it can have multiple classes of stock. The classes could have vesting and transfer restrictions that would provide incentive and retention features for management. This also provides incentives for employees to manage business risk more effectively. Insurance premiums paid to the captive should not be deemed compensation to the employee-owners for income tax purposes.

Benefits for Asset Protection

Generally, the assets of the captive insurance company should not be subject to claims by creditors of the hotel business. This assumes that the insurance premiums are reasonable and justified, the captive is not a sham, and that it was properly formed and operated.

Benefits for Shareholders

To the extent that claims against the captive's reserves are less than projected by actuaries and reflected in premiums, reserves grow and the captive stock becomes more valuable. Dividends can be paid to the shareholders from excess reserves which are subject to capital gain tax rates today. When the captive is liquidated, the proceeds received by shareholders is also treated as capital gain.