Q&A: How Can a Closely-Held Insurance Company Work for You?

SOURCE: InsuranceNewsNet, Inc.

August 8, 2008

QUESTION: What is a closely-held insurance company?

ANSWER: A closely held insurance company (CHIC or CIC) is a company – not an insurance product – owned and controlled by business owners to provide insurance for and sell insurance to the business and a number of other people.

Q: What is the difference between a CIC and a captive insurance company?

A: Some CICs are called captive insurance companies if most of the business it underwrites is exclusively that of a related business. However, CICs are not restricted to underwriting insurance for any related company. There are several kinds of captive insurance programs:

Single parent or "pure" captive provides insurance coverage to one sole owner.
Association captive provides insurance coverage for members of an established association.
Industrial insured captive enables the companies who own it to solve particular insurance problems.
Agency captive is owned by an agent or group of agents and functions as a reinsurance company.
Rent-a-captive provides underwriting profit and investment income participation returns to the insureds while taking care of members’ risks.

Q. How does a CIC work?

A: The business that owns the CIC pays premiums to it. The CIC insures the risks of the operating business. Unlike self-insurance, it involves the creation of a new insurance company with the potential to grow into a full-fledged and profitable insurance company from underwriting the risks of others.

Q. What are the advantages of a CIC?

A. A CIC provides several advantages for the business that owns it:

By forming its own insurance company, it can set more favorable premium rates than commercial rates.
It eliminates unavailability of coverage and can manufacture insurance contracts tailored to provide the protection needed by the participants.
The company is protected from wide price swings seen in the commercial insurance market.
CICs generally have better access to the reinsurance marketplace than traditional self-insurance programs.
The business has significant control over the claims settlement procedures.

Q: How is a CIC created?

A: Like all businesses, it starts with a comprehensive feasibility study covering financial analysis, legal research, actuarial projections, tax projections, domiciling options, comparisons and an insurance issues analysis.

In choosing an off-shore domicile location, the following should be carefully considered:

Political stability of the domicile and how conflicts may affect the ability of the CIC to function.
Distance of the location and the time required to travel between the CIC and the company.
Availability of qualified employees at reasonable cost at the location.
Friendliness and level of sophistication of the regulatory body in the location.

Q. What are the tax advantages of CICs?

CICs receive the same favorable tax treatment available to other insurance companies.
Tax exemption applies if the insurance company and members of its controlled group (which generally includes the CIC’s parent company and sister corporations) receive less than $600,000 in gross receipts with more than 50 percent in premium income, but it is subject to certain restrictions:

The company receives all insurance premiums tax-free.
Up to $299,999 in passive investment income as well as long-term capital gains, short-term capital gains, interest, dividends and royalties are not taxed.

However, the owner is taxed on dividends and compensation from the CIC. The owner will also pay a tax on gains in their stock value when the CIC is sold or liquidated.

Q. When is CIC an appropriate strategy?

A. Establishing a CIC may be a good alternative for companies that are unable to find the insurance they need. If available insurance products are too expensive, CIC could be more cost-effective for you. Due to its favorable tax treatment, CIC also works as a wealth transfer tool.

Q. How is a CIC used for wealth transfer?

A. For example, a 56-year-old client, married with three children, owns 100 percent of his company. The company produced $1 million of take-home income after all expenses were paid, bringing his total net worth to $7 million. He wants to transfer some of his assets to his heirs.

A CIC is created and owned entirely by his children or by an irrevocable trust with the children as named beneficiaries. The company buys various types of insurance coverage worth $300,000 to $500,000 from the CIC. Premium payments are treated as tax deductible business expenses.

The client is then able to transfer $300,000 to $500,000 into an offshore CIC without triggering a gift tax. Because the money is transferred to the children's offshore CIC, the client does not have to pay income tax.

In the event of any insurance claims, the money in the CIC is available for making the claims’ payment. But the primary purpose of this set up is to transfer the money as part of their inheritance.

Q. Can the client access the money inside the CIC?

A. It is possible for the client to access the assets inside the CIC tax-free, but the procedure can be very complicated.