Candidates for Small Captive Formation: Getting It "Right"

While overall captive growth continues, the total number of captives worldwide has experienced a slight downward blip, according to Business Insurance statistics shared by a panel on enterprise risk captives at the recent Captive Insurance Companies Association conference.

The panelists explained that, while captive numbers have seen a slight downward trend, captives (specifically larger captives) continue to grow in size. Panelists surmised that a number of factors have contributed to the drop in numbers, including mergers and acquisitions, consolidation, and liquidation, as well as the resulting effects from Notice 2016-66 and the Avrahami decision.

In light of the scrutiny placed on small captives, panelists said that getting small captives "right" involves reviewing the characteristics of each small captive candidate. While each situation is specific to the organization, the panelists identified the following considerations for determining whether candidates are suited for small captive formation.

Organizations wishing to set up small captives should have a reasonable business plan with consideration of the following.

• Small captives can only be formed by United States federal and state taxpayers.
• Small captives work well for privately held or closely held organizations (also for small public organizations).
• The small captive candidate's business should be cash flow positive.

Coverage planning for small captives should make sense for the organization.

• When looking at all of the encompassing risks, candidates for small captives have substantial high-severity/low-frequency risks that are uninsured or self-insured.
• Small captive candidates should also have substantial premium spend within the commercial insurance market, or they should have extremely expensive uninsured risks.

The captive candidate must be willing to take risk.

• Candidates should be willing to assume some risk and sometimes the risk of others (if a risk pool is needed).

The captive candidate must be willing to experience some loss.

• Candidates should be aware that a captive owner will have a loss and that it pays its own losses.

The captive candidate must be willing to put up capital (not a circular flow of funds).

• An organization wishing to form a captive must be willing to post the necessary capital. Typical capital is $250,000 up to $1 million+ depending on the business plan.
• The organization cannot be afraid to put some of its money at risk and leave it in place.

While the option of starting a small captive insurance company creates opportunity for organizations that may not have otherwise considered a captive, some organizations are better suited for small captive formation than others. Consideration should be made for a reasonable business plan, coverage planning, willingness to take risk, willingness to experience a loss and pay losses, and willingness to put up capital and leave it in place.

View a related video regarding the Avrahami decision.

(Panelists pictured above from left to right are Steven Miller, national director of tax, alliantgroup; Thomas Cyr, partner, KPMG; and Michael Serricchio, managing director, Marsh Captive Solutions. Photo above is courtesy of Captive Insurance Companies Association.)