February 1, 2011
Maximizing Value
By Neil Glassman and Trisha Hall
As captive insurance companies gain ground with middle market companies, many business owners are seeking ways to maximize the value of the captive vehicle, by enhancing the worth of family enterprises. An often overlooked strategy is to use a captive for personal wealth accumulation, a form of “estate planning” that makes sense incrementally, if the captive makes business sense in the first place. For smaller captives, the United States income tax advantages often will exceed the cost of operations, the savings from which can be invested for growth over the long-term. For those business owners who are subject to US taxation upon death, the wealth that accumulates in the captive will then pass tax free to the next generation. The benefits of this strategy are amplified by utilizing the laws of Delaware.
Traditionally the playground of the Fortune 500, captive insurance companies are becoming increasingly popular with the middle market, largely as a result of economies of scale and favorable US tax decisions in the early 2000s. Due to the fact that many businesses in the middle market are closely-held family-owned entities, advisors and captive managers have recognized opportunities to grow and shift wealth to the family through the ownership structure of the captive. Before taking advantage of these opportunities, however, the captive has to make sense for the business in the first place: risk transfer and risk distribution must be present, the business must insure actual risks, and actual claims must be processed. Where the insurance arrangement makes sense, the benefits of the captive extend beyond insurance and risk management.
The United States incentivizes companies to insure risk by offering certain advantages to them through its tax code. A business may take a current year income tax deduction for premiums paid for insurance whereas no such deduction exists for money set aside in reserve to cover future losses. A “micro-insurance company,” meeting the definition of section 501(c)(15) of the US tax code, does not pay income tax on either its underwriting or investment income, if the total income for the company is less than $600,000, no more than half of which is from its investments. A “small insurance company,” meeting the definition of section 831(b) of the US tax code, does not pay income tax on its underwriting income, but will pay tax on income from its investments.
In contrast to the tax treatment of insurance, the US penalizes individuals who die with significant wealth, also through the tax code. US gift, estate and generation skipping transfer laws impose taxes on intra-family transfers of wealth. After the imposition of these taxes, approximately one-half of the property transferred may actually be enjoyed by the intended recipients, with the government taking the other half. However, because these taxes apply only to gratuitous or below-market transfers, and premiums paid to a captive are actuarially determined payments for insurance policies, transfer taxes will not apply. Therefore, by structuring a captive insurance company so that it is owned by the business owner’s family, directly or, preferably, indirectly through a trust or other entity, the business owner can maximize the family enterprise value.
Domiciling a captive insurance company in Delaware, with its efficient, experienced and flexible regulatory scheme and environment, and its historically friendly and welcoming business and trust climate, is an excellent strategy to facilitate wealth accumulation and wealth transfer. Delaware offers by statute serialized legal entities in the form of a series LLC or a series statutory trust (here, referred to collectively as a series organization.) A series organization is similar to a protected cell captive in t
As captive insurance companies gain ground with middle market companies, many business owners are seeking ways to maximize the value of the captive vehicle, by enhancing the worth of family enterprises. An often overlooked strategy is to use a captive for personal wealth accumulation, a form of “estate planning” that makes sense incrementally, if the captive makes business sense in the first place. For smaller captives, the United States income tax advantages often will exceed the cost of operations, the savings from which can be invested for growth over the long-term. For those business owners who are subject to US taxation upon death, the wealth that accumulates in the captive will then pass tax free to the next generation. The benefits of this strategy are amplified by utilizing the laws of Delaware.
Traditionally the playground of the Fortune 500, captive insurance companies are becoming increasingly popular with the middle market, largely as a result of economies of scale and favorable US tax decisions in the early 2000s. Due to the fact that many businesses in the middle market are closely-held family-owned entities, advisors and captive managers have recognized opportunities to grow and shift wealth to the family through the ownership structure of the captive. Before taking advantage of these opportunities, however, the captive has to make sense for the business in the first place: risk transfer and risk distribution must be present, the business must insure actual risks, and actual claims must be processed. Where the insurance arrangement makes sense, the benefits of the captive extend beyond insurance and risk management.
The United States incentivizes companies to insure risk by offering certain advantages to them through its tax code. A business may take a current year income tax deduction for premiums paid for insurance whereas no such deduction exists for money set aside in reserve to cover future losses. A “micro-insurance company,” meeting the definition of section 501(c)(15) of the US tax code, does not pay income tax on either its underwriting or investment income, if the total income for the company is less than $600,000, no more than half of which is from its investments. A “small insurance company,” meeting the definition of section 831(b) of the US tax code, does not pay income tax on its underwriting income, but will pay tax on income from its investments.
In contrast to the tax treatment of insurance, the US penalizes individuals who die with significant wealth, also through the tax code. US gift, estate and generation skipping transfer laws impose taxes on intra-family transfers of wealth. After the imposition of these taxes, approximately one-half of the property transferred may actually be enjoyed by the intended recipients, with the government taking the other half. However, because these taxes apply only to gratuitous or below-market transfers, and premiums paid to a captive are actuarially determined payments for insurance policies, transfer taxes will not apply. Therefore, by structuring a captive insurance company so that it is owned by the business owner’s family, directly or, preferably, indirectly through a trust or other entity, the business owner can maximize the family enterprise value.
Domiciling a captive insurance company in Delaware, with its efficient, experienced and flexible regulatory scheme and environment, and its historically friendly and welcoming business and trust climate, is an excellent strategy to facilitate wealth accumulation and wealth transfer. Delaware offers by statute serialized legal entities in the form of a series LLC or a series statutory trust (here, referred to collectively as a series organization.) A series organization is similar to a protected cell captive in t