Everyone can benefit from understanding how captives operate. However, most people never learn about them. If you are one of the many who wants a brief understanding of this insurance method, read on for some key facts.
What Is a Captive?
To understand more about captives, we must start at the beginning. The strict definition of a captive is an insurance vehicle that is owned by its policyholders. You may be wondering how a company can insure itself because you have always understood that insurance is a contract that transfers risk to an insurance company. While this is an accurate definition and most captives abide by it, those that do not have any risk transfer do not receive the same tax benefits. Many single-parent captives do not satisfy the IRS definition. On the other hand, group captives generally satisfy this requirement because there are multiple shareholders that own risk in the captive.
Most captives cover things such as worker’s compensation, general liability, and at least part of expected losses. An actuary determines a company’s expected losses based on their financial history. However, captives generally only cover losses within a certain deductible. This means a company’s expected losses must remain under this number.
Captives must be formed in a state or foreign country that allows them to operate there. Bermuda and Vermont are popular places to form captives. However, 28 states have legislation allowing captives. For instance, North Carolina allows captive insurance policies.
How Do They Impact Your Taxes?
These captives typically take place in the commercial industry and operate almost the same as traditional insurance. For instance, premiums paid to the captive are deductible from your income taxes, just like with a regular insurance company.
If you are in the business world, you must understand what captives are. Captives are a way to protect your company without going through the traditional insurance market.