Published: Jun 2, 2022

The 2020 pandemic made it clear that business owners must establish a comprehensive risk management program to weather all storms. As risks go uninsured or underinsured, businesses have few options available to mitigate emerging risks such as pandemics, business & supply interruptions, and data breaches. One option is a captive insurance program or 831b Plan.

Like a 401k plan that allows for tax deferral for retirement savings, an 831b Plan allows for tax deferral to self-insure risks. 

To qualify under the tax code an 831b plan must meet certain criteria. Just as a business owner would engage a 401k plan admin to ensure they are meeting 401k guidelines, they will similarly engage a captive manager, or 831b plan administrator, to ensure their plan is meeting all guidelines.

Unfortunately for business owners, not all managers are created equal. Before implementing this risk mitigation strategy for your business there are a number of things to consider to ensure compliance, cost effectiveness and more. Here are 10 questions to ask a captive manager.

1. How are you meeting the 4-Part test?

A captive 831b Plan must meet four primary guidelines: 

1. Proper risk transfer - it must be clear that risk is contractually transferring to a third-party insurer; 
2. Proper risk distribution - it must be clear that the plan utilizes the law of large numbers to disperse risk among many parties;
3. Fortuitous risk coverage - the plan must cover fortuitous risks and not ordinary business risks; and 
4. Act within the principles of insurance - the plan must operate similar to how an ordinary for-profit insurance company would.  

2. How are premiums held? 

When business owners purchase coverage insurance premiums are contributed to the captive 831b Plan. How these premium contributions are held varies by captive manager. In many instances, funds are held by the manager for a certain period, in some cases up to three years. In such circumstances, these funds are kept within a dark pool that business owners have little to no oversight of. The captive manager has full control over the funds and participates in most if not all of the investment gains. Dark pools also create an environment for fraudsters to operate Ponzi Schemes.

3. How do you price your premiums?

Insurance premiums should be reasonable and determined by an independent third-party underwriter or actuary — the premiums shouldn't be arbitrary or set to meet a specific requirement. For example, plan premiums should not exceed the premiums charged by commercial insurers for similar coverage. Similar to commercial policies, premium payments should have a set schedule. 

4. What are your fees? 

Captive manager fees can vary significantly. Some captive managers charge a flat fee to include all services while others charge a la carte for services, leaving business owners to feel nickled and dimed. Transparency and simplicity are key.

Take note of the following fees: 

• Annual tax disclosure & return fees
• Actuarial fees
• Feasibility study fees
• Consulting fees 
• Claims adjudication fees 
• Dormancy fees 

5. What is your claims process? 

The primary function of a captive 831b plan is to pay claims as they occur. Just like ordinary insurance companies, a captive 831b plan must only cover those claims that it is contractually bound by the issued policy. To ensure claims are covered and paid properly, captive managers should have a written claims handling process. This process should be quite similar to traditional insurers with a claim filing procedure, claim investigation by an assigned claim adjuster, and a claim settlement process.

6. Will you help defend me in the event of an audit? 

Just as the 401k tax code initially drew the attention of the IRS, the 831b tax code does as well. As such business owners operating a captive 831b plan may have an elevated risk of being audited. A captive manager confident in their conduct, guidelines & procedures should assist in the event of an audit. A captive manager should have the legal and tax advisor resources to assist and should be willing to contribute financially to defend their customers.   

7. What can I do with premium reserves? 

As described above, the captive 831b plan must operate similar to how an ordinary for-profit insurance company would.  An axiom of the insurance industry is the investment of premium reserves to generate investment income. The captive manager should have an investment agreement that defines methods of investment as well as restrictions on investable assets. For example, an insurer typically invests in bonds & equities and would be unlikely to invest heavily in risky and/or illiquid assets. Some captive managers may suggest the purchase of life insurance with plan reserves. The purchase of life insurance within a captive 831b plan is questionable for two reasons: 1) lack of insurable interest; and 2) estate tax avoidance. Business owners should be cautious of managers recommending high commission products such as life insurance.

8. Does your company share in any of the risk? 

Depending on the structure of the captive 831b Plan, a manager may or may not retain a portion of the liability on written policies. Some captive managers charge their fees to administrate the plan while passing all of the insurance liability to the plan. Other captive managers retain a portion of the insurance liability that is proportional to their charged fee. Under the latter structure, the manager can be said to have “skin in the game” as it participates in losses when claims occur.  

9. What is your risk management background?

A captive 831b plan is first and foremost a risk management strategy; it follows that a captive manager should consist of experienced risk management professionals. Look for experience in property & casualty commercial insurance, corporate risk management, and professional designations. Managers consisting merely of tax attorneys or CPAs should be tested on their risk management knowledge.

10. Have you now or have you ever been under an IRS promoter audit? 

As stated above, the 831b tax code draws the attention of the IRS. A common practice by the IRS is to place a captive manager under a promoter audit. With such an audit, the IRS evaluates the practices and procedures of the manager to determine the validity of the plan under the 831b tax code. The IRS further collects client lists to audit the participants of the plan. Prior to engaging a captive manager it is important to know: 1) how it may have performed under such an audit; 2) if it currently is under such an audit or 3) how it would proceed if such an audit were to occur. 

If your captive manager answers these questions appropriately, you can feel confident in your 831(b) plan.

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