Micro-Captive Insurance for Collection Law Firms & Agencies

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