Captive Insurance Company

Summary of Captive Insurance Company

A subsidiary formed to insure the risks of its noninsurance parent or affiliated companies. The captive may also reinsure risks that have been placed with third- party insurers, all or a portion of which have been transferred subsequently to the captive; in this arrangement, the unrelated insurer is said to front for the captive. Captive insurers are normally formed in jurisdictions affording minimal capitalization requirements and limited oversight by regulatory bodies. For many years, Bermuda has been the primary base for captive insurance companies, although many captives have been formed in the Cayman Islands, Channel Islands, and more in the 1980s, certain U.S. jurisdictions, including Colorado and Vermont. The offshore jurisdictions are usually favored because the captive’s income may be sheltered from U.S. income taxes.

Captive insurers are usually organized along one of three lines: pure (or limited) captive, which insures or reinsures only the risks of its parent or affiliates; partial captive (also known as open market, broad, or senior captive), which insures or reinsures risks of third parties as well as its parent or affiliates; association (or industry) captive, which is controlled by several firms having common insurance needs and in which each of the member firms has an equity position.

The Internal Revenue Service has attempted to bring offshore captive income within the grasp of U.S. taxes by attributing the offshore income to the parent under Subpart F (read this and related legal terms for further details) of the Internal Revenue Code. In addition, the IRS has attempted to disallow deductions for premiums paid to a captive by its parent or affiliates, on the grounds that there has been no transfer of risk beyond the “economic family” of the parent; this proposition was advanced in Revenue Ruling 77-316 (read this and related legal terms for further details). The issue is under challenge in the courts.

(Main Author: William J. Miller)