by Howard H. Potter, JD, MBA, Managing Director, ST Consulting, LLC
Debt collection law firms and collection agencies utilize Micro-Captive Insurance Companies for risk management of self-insured risks and wealth accumulation. Historically,
only large companies formed captives. However, with the issuance of IRS Rev.
Rulings 2002-89 and 2002-90 the awareness, acceptability, and utilization of Micro-Captive Insurance Companies, qualifying under IRC 831(b) became a reality for smaller
businesses to use captives to fund and manage risks. There are now more than
1,000 micro-captives in the US with the majority of them formed in Delaware,
Utah, Montana and Nevada.
What is the concept of a captive insurance company?
The concept started as a solution to the need by businesses for insurance
coverage regarding risks that are not covered by conventional insurance
policies, such as deductibles, policy exclusions, coverages that are
unavailable or exceedingly expensive in the conventional market, or other risks
that are retained or otherwise self-insured. If a law firm or collection agency
tries to establish a sinking fund and accumulate a reserve without a Micro
Captive Insurance Company, it is funded with after tax dollars.
What is a Micro-Captive Insurance Company?
Micro-Captive Insurance Companies are structured to comply with IRS
code section 831(b) that applies to small property and casualty insurance
companies writing annual premiums less than $1.2 million. The principals of a law
firm or a collection agency set up the Micro Captive insurance Company which is
typically owned by the principals of the firm or agency, key employees or
trusts. Insurance premiums are paid by the law firm or collection agency
to a Micro-Captive Insurance Company and are deductible to the law firm or
collection agency but received by
the Micro-Captive tax free. Micro-Captive
distributions to the owners can be qualified dividends, taxed at 15%. Upon liquidation of the Micro-Captive,
distributions are taxed at long term capital gains rates. All insurance premiums
paid to a Micro-Captive Insurance Company must be actuarially supported by
independent sources. Current property and casualty insurance coverages through
third party carriers are sometimes modified by increasing deductibles and
thereby reducing the cost of commercially placed insurance premiums.
What's the Business Purpose concept?
For Micro-Captive Insurance Companies to be successful they must be
conceived, structured, managed and treated as a risk management tool. A
complete and thorough review and analysis is done for the
uninsured/self-insured risks of the law firm or collection agency. Considering
today’s Federal and State regulatory and economic environment that law firms
and collection agencies are faced with, the uninsured or under insured risks are
not difficult to identify. In optimizing risk management for a law firm or
collection agency, traditional high frequency risks continue to be covered by
conventional insurance policies and low frequency risk/high severity risks are
transferred to the Micro-Captive Insurance Company, resulting is a more
comprehensive insurance coverage for all risks.
What are the tax benefits?
The income tax benefits come directly from the Congressional intent of
IRS section 831(b). The law firm or collection agency receives an ordinary
income tax deduction for the insurance premiums paid to the Micro-Captive
Insurance Company, with the Micro-Captive Insurance Company receiving the premiums
tax free. Here’s a typical case in
point: with a maximum premium of $1.2M the premium generates a $400K to $500K annual
tax saving. Estate tax savings can also result from the structuring of the
ownership of the captive, i.e. the Micro-Captive Insurance Company is owned by
a trust for children or grandchildren. Insurance
premiums paid to a trust result in the transfer of ownership/wealth of the principals
the law firm or collection agency to the subsequent generations, but do not
trigger gift, estate taxes or generation skipping taxes. Think of it like
writing checks to your largest vendor, only you are the vendor, and all the
income is tax free.
What about firms that help set up a Micro-Captive Insurance Companies?
Forming and managing a Micro-Captive Insurance Company by yourself is
not easy. Selecting a Captive Management Firm to structure, form, and manage
your Micro-Captive Insurance Company is important since it helps to insure the financial
and tax integrity of both the structure and management. Captive Management
Firms should be willing to provide detailed financial statements, management
bios, and have a critical mass of captives under management (more than 100). The Captive Management Firm should provide complete
turnkey services for all aspect of the formation and management. You need a
captive management organization with depth, expertise, a proven history and staying
power.
For further information on Micro-Captive Insurance Companies, contact:
Ben Johnson at Cornerstone Support, Inc. at bjohnson@integrityfirstinsurance.com
Office: 678-740-0491
Cell: 770-519-2252
