The Captive Insurance Companies Association (CICA) has emphasised the importance of using best practices and qualified experts when designing and operating a micro captive, particularly those that use the Internal Revenue Code 831(b) election.
CICA published a document on 25 August outlining the steps that businesses must take when setting up a micro captive in the US, to ensure that they do not fall foul of the Internal Revenue Service’s (IRS) rules on their tax obligations.
Dennis Harwick, president of CICA, explained: “Well run captive insurance companies play an essential role in risk management and must be designed and operated to achieve risk transfer and risk distribution.”
CICA issued the information document to help its members and the public better operate and understand micro captive insurers. Harwick said: “Our mission to be the best source of unbiased information, knowledge and leadership for captive insurance decision makers.”
According to the document, for business purposes, the micro captive must have a valid non-tax business purpose centered on effective risk management through valid insurance arrangements.
Most micro captives participate in a risk distribution pool to minimise the impact of large losses, according to CICA’s document. The risk pool operator must be able to explain and document the proportionate share of risk being shifted to and from the pool, along with the actuarial basis for determining the premium.
The pool must also have a method of independently reviewing and approving claims, as well as a method for securing their payment.
Micro captives must also engage one or more qualified experts to determine whether they have a mechanism for distributing risk according to the IRS’s test for risk distribution.
The ownership structure of the micro captive has to accomplish the objectives of the business owner, including that this ownership structure meets the IRS’s test for risk shifting. Micro captives must not just operate as pass-through vehicles for profits to shareholders.
