What is a CHIC?
What is a CHIC?
A captive, or closely held insurance company (CHIC), is a property and casualty insurance company that is owned and controlled by the business owner to provide insurance for other businesses. The business that owns the CHIC pays premiums to it. The CHIC insures the risks of the operating business and, if required, diversifies its risk to satisfy the risk-shifting and risk-distribution requirements of the Internal Revenue Code. While the company is licensed to write insurance to the business owner and is registered with the IRS as a U.S. company, it is typically based in an offshore jurisdiction due to the more advantageous rules regarding capitalization, policy language and speed of formation.
Why Would a CHIC Be Right for You?
- Tax Advantages - Insurance companies are provided a special tax treatment. They can accrue tax deductible reserves for unpaid claims, whether known or estimated. The cash reserves inside of the CHIC are invested.
- Lower Insurance Costs - This is achieved through designing proper coverage limits, elimination or reduction of broker commissions and lower administrative costs.
- Cash Flow - Insurers rely on investment and underwriting profit to generate cash flow. Premiums are typically paid in advance while claims are paid out over a longer period of time. By utilizing a CHIC, premiums and investment income are retained within the CHIC. The CHIC can also provide a more flexible premium payment plan thereby offering a direct cash flow advantage to the parent.
- Access to the Reinsurance Market - A CHIC can access the reinsurance market which operates on a lower cost structure that a direct insurer.
- Flexibility - A CHIC can design the coverages that apply to the specific needs of the company and structure the policy accordingly.
- Coverage Provision - Captives can provide coverage for risks not available or that are too expensive to obtain in the traditional marketplace.
How does a CHIC work?
An individual, company or trust sets up and forms an insurance company. Once licensed, the CHIC functions just as most insurance companies do. It can sell insurance coverage (but generally such sales are only to its owners), receive premium dollars and invest them to pay claims and, when needed, approach the reinsurance market to purchase reinsurance to cover losses.
If the insurance claims are low, the CHIC will, over time, accumulate significant money. Depending on the structure of the CHIC, the income will be taxed in various ways during the wealth accumulation phase (as well as the payout phase) to the CHIC owner when money is needed.
Why form your own CHIC?
There are four main reasons:
- Obtain special policy coverages not otherwise available
- Income tax advantages
- Wealth building
- Estate tax planning
If your company pays insurance premiums to the captive insurance company, it is generally tax deductible for your business - but the receipt of premium income is tax free to the CHIC. If there are no or few claims against the insurance company, the reserves will accumulate much quicker and there will be a more profitable company. More profits, in turn, could result in greater gain for the shareholder. At the time of retirement, you can close down the insurance company, disburse the accumulated profit and receive such increased value as a long-term capital gain. Currently, long term capital gains are taxed at a maximum federal rate of 20%.
- 831(b) Election - An insurance company may elect to be taxed on its investment income only as long as the company receives no more than $1.2 million in premiums each year.
- 953 (d) Election - An insurance company that is formed offshore may elect to be taxed as a domestic US Corporation. This election requires the offshore insurance company to pay taxes the same as a domestic US Corporation. This eliminates any problems that could occur by the Controlled Foreign Corporation rules and allows for full reporting and payment of any taxes due to the IRS.