Insurance strategies

Captive Insurance Strategies Can Pay Off For Real Estate Operators – Real Estate & Construction

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Federal tax law has permitted US corporations to incorporate so-called “captive” insurance companies for many years, and many large corporations have done so. It is only relatively recently that the arrangement has gained traction with smaller public and private companies.

Could your real estate business benefit from pursuing captive insurance strategies? To find the answer, you must first understand how they work, as well as the potential advantages and disadvantages.

The fundamentals

Captive insurance is a form of self-insurance where the insured fully owns the insurer. The captive insurer can cover the parent company and any subsidiaries.

In a real estate context, this arrangement can be a welcome alternative when traditional third-party coverage is too restricted, limited by multiple exclusions or subject to high deductibles. Companies that form their own captive insurers can tailor coverage to their specific risks.

Captive insurance companies typically cover property damage, including that caused by windstorms, hail, and other weather-related events, as well as environmental liability, including mold and chemical remediation. Other risks covered by captive insurers include:

  • Loss of rent;

  • automobile civil liability;

  • Liability of directors and officers;

  • Interruption of work; and

  • Excess commercial civil liability.

You can even use captive insurance to cover deductibles on existing coverage with traditional carriers or to obtain coverage that is not otherwise available or affordable.

Potential Benefits…

The main advantage of a captive insurance contract is the savings on premiums: you control costs and services, rather than a third party for profit. Even better, you can take advantage of a tax deduction for premiums paid. This contrasts with typical self-insurance coverage, where you cannot claim tax deductions until claims are paid.

In addition, since the parent company owns the captive, it receives the captive’s underwriting profits (the excess of premiums over expenses). Underwriting profits and accumulated surplus are exempt from tax for the captive. Distributions to the parent are taxed as dividends at lower capital gains rates, rather than ordinary income tax rates.

As a parent company, you also directly benefit from any effective cost or risk management strategies you implement. Therefore, companies that have adopted the captive insurance model tend to focus heavily on basic risk management practices.

Related reading:
“Is it time to review captive insurance?”

…and the cons

Captive insurance is not without its drawbacks. For example, if claims exceed premiums, you will be affected by the captive’s underwriting losses. Additionally, the smaller risk pool of insureds makes a captive insurer vulnerable to catastrophic losses. And captive insurers must comply with federal and state insurance laws and regulations, including capitalization requirements.

Certain captive insurance arrangements have also been designated as “interest transactions” with the potential for tax evasion by the IRS. The agency has acknowledged that “micro-captive” insurers may be created for “legitimate risk management purposes”, but it still imposes strict self-disclosure requirements on such relationships. The IRS reviews micro-captives to ensure, for example, that premiums are properly set and risks are properly allocated among policyholders. To avoid running into problems, have a legitimate business reason for forming a captive, such as better hedging or better risk management. If tax savings are your primary motivation, you could be in trouble.

Finally, running an insurance company requires a certain investment. You can count on start-up, claims management and administration fees, licensing and related fees, audit fees and attorney fees. And remember that each state will have separate laws and regulations governing this type of insurance arrangement. Be sure to check with your ORBA contact to ensure that you are not only following federal laws, but also the laws of any states where you operate.

Acquire help

Under the right circumstances, captive insurance has a lot to offer property operators. It allows you to customize insurance coverage, benefit from significant tax advantages and additional benefits, and better control risks and costs. But do not take the plunge until you have consulted both your lawyer and your ORBA contact.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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