Fortune 500 companies and large nonprofit organizations, like hospitals and medical schools, have used captives for decades to self-insure against predictable risks, like workers’ compensation or malpractice claims. (The New York Times Company has a captive insurance company called Midtown Insurance Company.)
But in 2002, the Internal Revenue Service issued guidance on how to set up captives to comply with the tax code, and that gave way to a rush to form them, said Jay Adkisson, chairman of the American Bar Association’s committee on captive insurance companies and a former owner of such a company in the British Virgin Islands.
“Today it’s hard to find a major company or university that doesn’t have one,” he said.
Now financial advisers are increasingly pitching captives to smaller businesses, including physicians’ groups, restaurant owners and companies that want to cut the costs of health insurance for their employees. They are being portrayed as a way not only to save money on insurance premiums but also to reduce income taxes and transfer money to heirs free of estate tax.
But the rush to set up captives could lead to problems for the business owners and for people filing claims against them.
INSURANCE PURPOSE From the point of view of the companies that set up these entities, captive insurance companies make perfect sense.
If a business paid a premium of $1 million to a regular insurer and had only $600,000 in claims, it would lose $400,000. If, however, it put the same amount of money into a captive, it would keep the extra $400,000 in the captive. This amount would then increase over the years.
Of course, that company could end up having $2 million in claims the first year. It would have to have a reinsurance policy to cover the claims, or pay them out of its reserves.
Mr. Adkisson said a captive could be seen like any other subsidiary. “A guy who owns a car lot can buy a carwash and wash his own cars,” he said.
So when should a small-business owner think about setting up a captive?
Jeremy Huish, director of business development at Artex Risk Solutions, which administers captive insurance companies, said risk management should be the motivation.
“You need to have enough risk to justify the captive,” he said. “If you take a doctor group and they cut people open for a living, they’re going to have more risk than an accounting firm.”
Jeff Kurz, president of Red Hook Risk Services, a consultancy to hospitals, nursing homes and groups of doctors looking to set up captives, said such an arrangement could generally be worth considering for businesses with more than $750,000 in taxable income and more than $1 million in insurance premiums.
But he said it was important to pay attention to risk. “A huge misnomer is I’m going to start a captive and save a lot of money next year,” he said. “You might not set aside enough money to pay for the claims down the road.”
Ken Sturm, who owns several restaurants and nightclubs, including P. J. Clarke’s and Iridium Jazz Club in New York, said he became interested in having a captive insurance company when his traditional insurance policy did not cover a claim. Several years ago, one of his restaurants in Times Square was closed for three days because of work in the neighborhood, but his policy had a waiting period of 96 hours before the insurance covered any losses.
The captive he set up covers such losses. “I can write specific policies that go above and beyond my typical commercial liability coverage,” Mr. Sturm said. “Business interruption coverage. Data breach. Legal fees. You can do deductibles.”
He said he paid $25,000 to set up a captive and pays Artex $36,000 a year to maintain it.