UNDERSTANDING 831(a) CAPTIVE vs. 831(b) MICRO CAPTIVE INSURANCE
In today's competitive business environment, proactive business owners face the challenge of protecting their companies from various risks, both known and unknown. Rising commercial insurance premiums can pose a significant financial burden, but there’s a proven solution many companies have used for 38 years—captive insurance.
This high-level introduction will walk you through the key distinctions between 831(a) captive and 831(b) micro captive insurance companies and help you decide which approach is best for your business.
THE BIRTH OF CAPTIVE INSURANCE
In 1986, as the U.S. economy emerged from a recession, Congress introduced a provision within the tax code, rooted in practices dating back to 1919 when General Motors established a wholly-owned insurance entity. This provision became what is now known as captive insurance, enabling businesses to reduce commercial insurance premiums and underwrite unique risks. Today, businesses can choose between two types of parent-company-owned insurance entities:
- 831(a) Captive Insurance Company
- 831(b) Micro-Captive Insurance Company
KEY DIFFERENCES BETWEEN
831(a) and 831(b)
| Topic | 831(a) | 831(b) |
|---|---|---|
| Federal Income Tax | Taxed at regular corporate rates | 0% federal tax on underwriting profits |
| Risk Coverage | Designed for large corporations | Best for small to mid-sized businesses |
| Regulatory Scrutiny | Lower scrutiny | Higher scrutiny |
| Premium Limits | No specific limit | $2.8 million in 2024 (with an inflation rider) |
WHEN 831(a) CAPTIVE INSURANCE MAKES SENSE
A traditional 831(a) captive insurance company is typically a good fit for large corporations with extensive global operations. These companies face more significant risks and often seek ways to reduce the premiums they pay to third-party insurers. A single-parent captive is owned by one large company, while group captives, often formed by industry associations, insure the collective risks of member companies.
However, 831(a) may not be the best option if:
- Your company has insufficient profits to pay premiums consistently.
- The savings in premiums don’t offset in-house management costs.
- You lack the financial resources or personnel to manage the captive entity.
THE 831(b) MICRO CAPTIVE INSURANCE PLAN
For small to mid-sized businesses, an 831(b) micro captive insurance plan offers substantial risk mitigation benefits, with the added advantage of tax deferral.
Here’s what you need to know:
- Business Type: Closely-held, private businesses in nearly every industry can benefit.
- Gross Revenues: Your business should have annual revenues of at least $1 million.
- Gross Premium Income: The 831(b) plan allows for up to $2.8 million in premiums annually (2024), with an inflation adjustment.
WHAT THE 831(b) PLAN IS NOT
While the 831(b) plan offers notable advantages, it’s essential to understand its purpose:
- It is not a strategy for lowering taxes.
- It is not an unrestricted access point for cash reserves.
Like any other insurance company, an 831(b) micro captive operates for profit by processing claims with substantiating paperwork and procedures.
Compliance and the 4-Part Test
An 831(b) plan can face scrutiny if IRS rules aren’t strictly adhered to. A qualified plan administrator helps ensure compliance through what’s known as the 4-Part Test, ensuring the plan meets the following conditions:
Risk Transfer
There must be a contractual transfer of risk from the operating company to an insurer. The SRA 831(b) Plan utilizes a Direct Writer that underwrites the risk and issues policy contracts to the operating company in exchange for premium.
Risk Distribution
In order to reduce the possibility that a single claim exceeds the amount of premiums collected, the 831(b) Plan must utilize the law of large numbers to disperse risk among unrelated parties. Each 831(b) Plan ARC administered by SRA is allied with others in risk co-ops that share each other’s risk on a pro rata basis.
Fortuitous Risk
The risk being contractually transferred must be fortuitous in nature and not considered to be an ordinary business risk. SRA’s Direct Writer underwrites many different risks that are fortuitous in nature including business interruptions, dispute resolution, political risk, brand damage and many more.
Insurance Principles
The 831(b) Plan must act just as an ordinary for-profit insurance company would by following the principles of insurance. These principles include: contractual transfer of risk, utilization of the law of large numbers, a defined methodology to determine premium, a defined claims process to determine covered losses, and managing reserves to generate investment income.
