831(b) captives often cover risks that are either unavailable, too expensive, or too difficult to insure in the traditional market, including policies such as  business interruption, cyber liability, reputational risk, regulatory changes, supply chain disruption, legal and audit expenses, etc.

Captive insurance is becoming more common due to skyrocketing insurance premiums and the growing coverage exclusions. A historical combination of lack of awareness and the complexity of establishing and managing these entities bears partial responsibility. Many businesses and advisors need to become more familiar with the benefits and possibilities that captive insurance can provide.

Premiums paid into an 831(b) captive are often based on the unique business risks tailored to the specific parent company needs and risk appetite, unlike traditional insurance premiums which are standardized and based on more general and broader market risks.

'Enterprise Risks' refers to “below-the-surface” risks specific to a business or industry that are shared with other companies in multi-member “risk pools” to satisfy risk distribution requirements for a single business needing non-traditional coverage such as supply chain disruptions, business interruptions, legal or audit protection, and many additional non-traditional risks.   'Safe Harbor Risks', described in 2 successive IRS Safe Harbor rulings, allow for captive insurance protection against non-typical risks faced by small businesses (typically not covered by commercial insurers), where the business owner qualifies and forms an 831(b) captive relying on their own clients to establish the “safety-in-numbers” satisfying IRS  risk distribution rules of carrying “12 or more risk units.” An auto dealership that offers an extended warranty is a prime example of a Safe Harbor Risk captive.

At a minimum, a profitable small business must generate $3.5M annually or more in gross revenues, have at least 5 years in business. If your business participated in the federal government’s programs of PPP and ERC, or was negatively impacted by the pandemic brought on by your state’s response to the pandemic, chances are, you’re a prime candidate for establishing a captive insurance company.

 1) There must be risk transfer, 2) There must be risk distribution and risk-shifting requirements, 3) The risk must be “fortuitous risk” which is defined as an “unforeseen, real, and insurable risk that can be effectively transferred to the captive,” and 4) The captive must adhere to established “insurance principles” such as a) following a defined & written claims process, b) prove the management of surplus reserves follows domicile rules, c) utilize a “defined premium methodology,” and d) following the principle of “the law of large numbers.” Understanding and remaining compliant with the above “qualifiers” comes from working with an experienced third-party captive plan manager who guides each client and ensures all 831(b) rules & regulations are followed. If  these criteria  are met and maintained, the insurance company may receive up to $2,800,000 in annual premium in a tax-favored status, whereby the insurance company will not be taxed on the premiums received. 

The benefits of captive ownership are vast and vary to the uniqueness of your company. In short, customization allows for a bespoke design specifically to your company’s needs. Improving the overall risk management and operational cash-flow allow for an enhanced long-term stability.  Benefits of 831(b) Captive Ownership.  

Our selected Plan Administrators are usually able to complete the process in 2 - 4 weeks if the business client is willing to fully participate in education, strategy, and providing the necessary information promptly

A captive can be designed to cover specific, “non-traditional” risks unique to your business that traditional insurers may not cover. We call these “below the surface” risks and thus allow for providing tailored risk management solutions. 

To put it simply, with the IRS’ proposed regulations in 2023, the path to a properly structured 831(b) insurance company is easier than it has ever been. The IRS wants to know it’s about the insurance, not the taxes. Based on historical misuse of the 831(b) for tax avoidance and estate planning purposes rather than insurance protection, the IRS has focussed on “pre-reg” micro captives that were not used to manage real risk. A “post-reg” environment, where compliance is much more clear, ensures a properly designed insurance company can be established for legitimate risk management purposes and not merely for tax avoidance.  In the past, the IRS has scrutinized businesses that appeared to be leveraging a captive structure primarily to avoid paying taxes and rather than focussing on essential & fundamental insurance principles. If you follow the rules, you have no reason to be concerned. IRS 831(b) Rev Rulings over the past 20 years

Litigations have highlighted the importance of genuine risk transfer, adequate risk distribution, and operating consistent with insurance principles. Captives that function as bona fide insurance companies withstand scrutiny. See our list of most recent IRS court case findings that benefit 831(b) managers & owners with “ lessons learned” from mistakes and failures to operate in compliance. As an aside, the IRS only litigates the most egregious cases that have the highest probability of victory for the IRS. Through recent FOIA requests by lobbying groups representing the industry, it was learned that the IRS settled 80 cases for $1, while litigating eight through the Tax Court. You read that correctly! 90% of the 831(b) plans litigated essentially won, but the IRS keeps that information private.

Captive insurance regulations are set by the insurance departments of the domiciles in which they are licensed, with additional oversight by federal entities like the IRS for tax purposes. 

Selecting the right plan manager and domicile for a small business captive insurance company is crucial because these decisions significantly influence regulatory compliance, cost-efficiency, and the overall success of the insurance operations. The right plan manager provides expertise in navigating complex regulatory landscapes and managing insurance risks effectively. The ideal domicile offers favorable regulatory conditions and potential tax advantages, impacting the captive's operational efficiency and financial performance. See Domicile Selection Considerations

The lifespan of a captive can vary widely, often operating as long as it serves the business needs effectively. Exiting a captive generally involves a formal dissolution process, which includes fulfilling all financial obligations outlined within the insurance policies. To ensure all claims are settled and procedures are followed correctly, reliance on the TPA (Captive Manager) is essential.

For 831(b) captives, the IRS allows insurance premiums up to $2.8 million annually (as of 2024). All captives must have sufficient premiums to cover the insured risks and demonstrate risk transfer. The basic rule of thumb for when it makes most sense is a profitable business with at least 5 years of being in business, and at least $3.5M in gross annual revenues.

The investments of a captive are overseen by the Investment Agreement between the Ceding Company and the Captive Insurance Company. Guidelines for the Agreement are provided by the Domicile’s Insurance Department. The Agreement usually requires conservative investment strategies for a specific % of funds to ensure liquidity and that the captive can meet its claims obligations. 

CPAs unfamiliar with captive insurance requirements pose a challenge in strategic financial planning, compliance with tax rules, and optimizing the benefits of owning a captive. It's advisable to work with seasoned tax advisors experienced in captive insurance. 

Risk pools vary from plan manager to plan manager, but may include areas like business interruption, supply chain disruption, cyber & data breach protection, government regulation change, pandemic-related conditions, etc. See a list of both Enterprise Risk and Safe Harbor risk profiles.

Total annual costs can vary widely based upon the types of coverages. However, costs can include capitalization requirement, start up fee, annual management fee, premium taxes and fees, retained liability premium, annual tax returns and filings,  actuarial services, feasibility study, consulting fee, claims handling, loan or dividend docs, termination fee, dormancy fee, etc. 

Managing an 831(b) captive insurance company is similar to a 401(k) plan requiring meticulous compliance with regulations, proactive financial oversight, and strategic planning to meet specific goals. For both, a Third-Party Administrator (TPA) is required due to the complexity of these regulations and tasks. A TPA ensures compliance with legal and regulatory requirements, handles claims administration, manages funds, and provides expert guidance on best practices. In the case of an 831(b) captive, the TPA also plays a critical role in ensuring that the insurance operations meet the essential Four-Part test.