Captive Insurance
A captive insurance company is a licensed insurance subsidiary formed by a business or group of businesses to insure the risks of its parent or affiliated entities, allowing the parent to fund its own insurance risks in a more controlled, potentially tax-advantaged structure.
Captive insurance is a form of self-insurance in which a business creates its own licensed insurance company rather than purchasing all coverage from commercial carriers. The parent business pays premiums to the captive, which accumulates reserves to cover future claims. If the captive operates profitably — meaning actual losses are less than premiums collected — the profits remain within the captive and can eventually be returned to the parent through dividends or other distributions.
There are several captive structures. A single-parent captive (pure captive) serves only its parent and affiliates. A group captive pools risks from multiple unrelated businesses in the same industry. A rent-a-captive or protected cell company allows smaller businesses to participate in captive insurance without forming their own entity by renting a cell within an existing structure.
The potential tax benefits of captive insurance come from the ability to deduct premium payments made to the captive as ordinary business expenses while the captive accumulates reserves in a tax-advantaged environment. For small captives — those writing $2.85 million or less in annual premiums as of 2024 — Section 831(b) of the Internal Revenue Code allows the captive to elect to be taxed only on investment income, not on premium income. This election has been used aggressively in some arrangements that the IRS has identified as abusive tax shelters.
The IRS has placed micro-captives on its listed transactions and transactions of interest lists in multiple years, requiring disclosure and scrutiny of arrangements it believes primarily serve tax avoidance rather than legitimate risk management purposes. To withstand IRS scrutiny, a captive must write genuine, commercially reasonable risks at arm's-length premiums, maintain adequate capitalization, pay legitimate claims, and be managed with proper actuarial support.
Legitimate captive insurance is a well-established risk management tool used by many large corporations, healthcare systems, and trade associations. The structure is most effective when the parent has consistent, quantifiable risks that are either uninsurable or available only at unfavorable terms in the commercial market.