Businesses that are difficult to insure through traditional means can establish their own insurance companies. These companies typically insure against specific risks, such as oil leaks in an offshore drilling operation. These insurance companies are captive insurance companies, and they offer more benefits than risk mitigation.
Captive policies may be used to shift or distribute corporate risk. To fund a captive, companies may increase deductible limits on policies offered through traditional insurance policies, such as malpractice. Captive policies may also be used to reimburse deductibles. Commercial liability policies may not cover product liability, so captives may supplement this coverage. Employment, environmental, and cyber or data risks may also be covered using this type of insurance. Finally, legal fees and business income losses may be paid through these policies.
Companies use captives to insure against very specific risks. However, these risks must be clearly defined in the policy. Because they are formed by companies, the policies can be tailored specifically to the company’s needs. This allows companies to save money because they are not required to pay for insurance in areas that do not pose a significant risk to their companies. In addition, these policies can be customized to such an extent that even third parties cannot make claims against the captive’s assets or the company’s policy.
The captive formation is costly and complex. These companies are scrutinized carefully by the Internal Revenue Service. Parent companies must be careful not to pay premiums that are much higher than the level of risk would require. Corporations must also have in-depth planning and analysis, including feasibility studies, prior to the captive’s inception. They must also watch how often claims are made and paid out against their policies. In these situations, the IRS may investigate the company for tax evasion.