831(b) Enterprise Captives
831(b) Enterprise Captives
Profitable mid-size companies use 831(b) enterprise risk captives to finance risks the traditional market will not cover. When properly structured they may carry tax advantages, and they draw close IRS attention.
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Do you even know what they are?
831(b) captives take their name from section 831(b) of the Internal Revenue Code, which came out of the Tax Reform Act of 1986. The section is titled "Alternative tax for certain small companies."
These captives are also called micro-captives, mini-captives or enterprise risk captives. Profitable, cash flow positive mid-size companies use them to finance and transfer risk the traditional market will not insure. When they are properly structured, an 831(b) captive may offer financial, estate and tax advantages, depending on how it is set up:
- A way to build a loss fund, tax favorably, so the business has cash to pay a loss the traditional market would not normally insure.
- Premiums the business pays to the captive may be a deductible business expense.
- The captive elects at its start to be taxed only on its investment income, not on the premium it collects.
- Underwriting profits returned to the owners may be taxed as capital gains instead of ordinary income.
- The captive can be owned by the business owners or by others, including family members.
Every one of those points depends on the captive's structure and documents. Talk with your tax advisor before you go down this road.
The limits
There are limits. The captive has a maximum annual premium set in the tax code, and it cannot pay a third party directly. It can only reimburse the insured business for covered losses. Because of that, an 831(b) captive is mostly used for risks no traditional insurer will cover, or to fill holes in an existing program.
The risks you may not see
Your business faces many exposures in its daily work that you may or may not recognize as a threat to its success, or even its survival. They include, but are not limited to:
- Political risks: civil unrest, terrorism, war or intentional violent acts
- Regulatory: unintentional loss of personal or business licenses, statute changes
- Contingent liabilities: weather, lack of materials or manpower
- Trade credit: loss of value, accounts receivable
- Business: loss of a key client, franchise or supplier relationship; loss of bonding capacity; material price swings
- Financial: interest rate and foreign exchange rate swings
- Reputation: brand value, key person or corporate image
- Competition: price wars
- Service contracts: furniture, appliances, autos, equipment, homes
- Non-ERISA medical plan losses, such as HRAs
- Large deductible losses: workers' comp, medical plan, liability
Those only scratch the surface. You can probably think of other risks that are not insurable, or not affordable, in the commercial market.
One way to find the risks you are not insuring: open your liability and property policies and read what they say is not covered, such as paved surfaces, bridges or underground property, or what is specifically excluded, such as your product, your work or intentional acts of an employee. Many of those exposures can be handled through an alternative approach like an 831(b) captive.
An important note
The IRS and the courts have challenged 831(b) captives, and the IRS continues to look at them closely. How a captive is structured, priced and documented matters a great deal. The two issues that draw the most scrutiny are risk transfer and risk distribution.
Risk transfer
There has to be a clear, documented transfer of risk from the operating company to the insurance company. That is done through an insurance policy with actuarially determined premiums and clear insuring conditions and policy terms.
Risk distribution
The insurance company needs third party business, unaffiliated with the operating company, in its written premium. No regulation sets the required level. Third party business can come from pooling exposures with other captives, buying unrelated business from other carriers, and in some cases policies the captive itself issues.
After reading all of this you might think the federal government does not like 831(b) captives. That is not the case. Congress has raised the premium limit since the section was created. The government understands the need for a properly structured 831(b) captive. It is trying to keep them from being abused. Your tax advisor should be part of any decision.
Turning Premiums Into Profits
David Leng's book on captive insurance is written for business owners who are tired of the same insurance cycle every year. It explains how a business paying more than $100,000 a year in premium can take on some of its own risk in exchange for the potential rewards, and why captives have become the most widely used way to do that.
Watch: 831(b) captives
Where the Employer Success Program comes in
It starts with a Diagnostic and Plan. We read your loss runs, your mod worksheet and your key contracts, and we talk with the people who run the work. You get the pattern behind your claims and a short list of what's worth fixing first.
From there our claims, HR, safety and fleet people work alongside yours, and you get a Score Card at the start and every year after, measured against your own starting point.
Start with a conversation
Tell me what's going on. I read these myself and reply within two business days. If there's nothing worth fixing, I'll tell you that too.