Capitalization requirements, high operating costs and fear of regulatory scrutiny have discouraged small and midsize businesses from establishing captive insurers in the past, but the environment is changing, experts say.
A greater variety of captive structures has accelerated growth, but small businesses should conduct due diligence and review all options before rushing into a captive, they say.
Cell and group captives can lower the barriers to entry to the alternative risk transfer market for small and midsize companies, said Ellen Charnley, president of Marsh Captive Solutions in Las Vegas.
“In a more challenging commercial market, the uptake for cells generally has been greater than in a softer insurance market because of the speed of forming a cell,” Ms. Charnley said.
Policyholders looking for an alternative to increasing commercial market rates often need to move quickly, she said. Cell-type captives may also allow for lower capitalization levels and lower operating costs, she said.
Businesses of all sizes, including small and mid-size companies, are considering or forming captives, said Andrew Vernon, Chicago-based senior vice president at Captive Resources LLC.
“Whether it’s a publicly traded company paying $25 million a year in insurance or a mom-and-pop paying $150,000, the end goal is going to be the same. All of these companies are looking for a different method to cut costs, to find stability in a rapidly changing insurance marketplace,” Mr. Vernon said.
Group captives offer cost savings and efficient risk management for smaller businesses in various industries, including construction, transportation and temporary staffing, he said.
In the past, it was easier for larger companies to form captives because they could more easily meet the capitalization requirements and had the resources required to establish a new corporate entity, said Sandy Bigglestone, deputy commissioner of the captive insurance division of the Vermont Department of Financial Regulation in Montpelier.
“That’s changing,” she said. The introduction of cell legislation in various domiciles has expanded the types of captives offered and spurred growth among small and midsize companies, she said.
Vermont has 64 sponsored captives, which house captive cells, and more than 500 cells and separate accounts within those entities, Ms. Bigglestone said. Not all cells are formed by small businesses; many companies “incubate” the idea of a captive and test it out within a cell, she said.
Of the 659 licensed captive insurance companies domiciled in Vermont as of year-end 2023, 378 wrote gross written premium of $10 million or less and 306 of those wrote $5 million or less in gross written premium, according to a recent report by the Vermont Department of Financial Regulation.
Small businesses considering a captive should conduct a cost-benefit analysis of different captive structures, including group and single-parent captives, said Peter Kranz, senior vice president at Alliant Services Inc. in Burlington, Vermont.
The benefits of how much profit they will capture versus the operating cost of a captive and how much risk they will take should be weighed, he said.
“Typically, with smaller companies, it’s tougher to get to where that makes sense because you just don’t have enough premium dollars to do it,” Mr. Kranz said.
Rent-a-captives, series-type captives, incorporated or protected cell facilities can differ significantly, said Nate Reznicek, president and principal consultant at Captives.Insure LLC, based in Knoxville, Tennessee.
“In many instances, these facilities are owned by a captive promoter, maybe a captive manager or brokerage facility, and the facilities have been designed sometimes to the benefit of that owner to incentivize them to have greater client retention,” Mr. Reznicek said.
It’s important that new captive shareholders and their brokers compare the captive solution presented to them with other options to determine what is the best fit for the client, he said.
Smaller companies looking to benefit from 831(b) tax elections – under which the U.S. government taxes them only on investment income if their annual premiums are less than $2.8 million – should exercise particular care, several experts said.
The IRS’s continued investigation of 831(b) captives and its run of successful court wins against 831(b) owners it alleges were not using the captives for insurance have led some owners to shut down microcaptives.
“There’s a certain stigma to a captive making an 831(b) election and rightfully so because there were a lot of abuses in the past,” Mr. Kranz said.
There’s a misconception that microcaptives are from microbusinesses, but “that’s not the case at all,” said Mr. Reznicek, who is also an adviser to the 831(b) Institute in Miami, Oklahoma.
831(b) captives may be used to write relatively small deductible buybacks or layers within a property tower for large real estate businesses with billion-dollar property schedules spending $30 million on premium, for example.
The added IRS scrutiny has prompted frank conversations around the potential tax implications for captive structures among small and large organizations, “which is a good thing,” he said.
