The Florida Bar

Florida Bar Journal

Captive Insurance Companies: Florida Enters the Arena


In the 2012 legislative session, Florida adopted totally revised captive insurance company legislation to replace the old F.S. §628.901, which was relatively barren and simple and rarely used, if at all. The Florida Insurance Code does not apply to captives.1 The new law became effective July 1, 2012. It is Florida’s plan to be competitive with other states, such as Vermont and Delaware, in developing and attracting captive insurance businesses in Florida instead of having them flee the state or country.

A captive insurance company is one formed by a business owner to insure risks of his or her operating business and affiliated companies. The operating business pays a premium to the captive, and the captive insures the risks of the operating business. It must be operated as a real insurance company with reserves, surplus, insurance policies, policyholders, claims, etc. It must be licensed as an insurance company in the venue in which it is formed. The insurance policy and the risks covered therein must be based on professionally tested insurance experts to provide the same business risk/profit used by all insurance companies, and there must be a clear and insurable risk for each policy.2

Captive insurance companies have been around for a long time (since 1982 in Florida). For the most part, large national and international public companies utilize captive insurance companies. Lately, however, many smaller businesses are utilizing them for all the benefits that they provide. For federal income tax purposes, the company can provide insurance to itself through an affiliate, and the payments are deductible as with any other insurance company. However, Internal Revenue Code §831(b)(2) provides that if net written premiums do not exceed $1.2 million, premium income is not taxable to that company if that company so elects. I.R.C. §831(b)(1) provides for tax only on investment income. Coupled with the fact that an entity may be owned by children and other heirs, this is a business venture and is, thus, not a gift for purposes of calculating the lifetime gift tax exclusion utilized by the owner of the business.

The captive provides the means by which a business owner can increase profitability by creating a profit inside the captive and reducing insurance costs in the operating company. The profitability at the insurance company level is higher for companies that have lower claim experience. This lower claim experience can also reduce the costs of insurance at the operating company level by increasing the amount of deductibles or coverages on many insurance policies already in existence at the operating company. The captive then invests the premiums at a profit, and by not having to pay out as many claims as the average insured (the basis upon which the premiums are calculated), additional profits are achieved by both companies.

In addition to these increased revenues, the administrative cost of running a captive is substantially lower than the administrative portion of the premiums charged by insurance companies, including agents’ commissions, advertising, costs of compliance, offices, and administrative costs, which is often based on salaries. Some other benefits include increased claims control, access to reinsurance markets, which is usually only available to a licensed insurance company, and better policy terms.

Provisions added by the new Florida statute include unimpaired paid-in capital of $100,000,3 plus a surplus of $150,000,4 for a total of $250,000 for a pure captive company. Further, it must have at least $250,0005 of unrestricted assets. For industrial captives, the capital requirements are increased to $200,000,6 plus $300,0007 of surplus, for a total of $500,000. However, these capital requirements may now be provided for utilizing an unrestricted bank letter of credit.8

An “industrial captive” is one that insures “industrial insureds.” Industrial insured means one that has gross assets in excess of $50 million; has at least 100 full-time employees; and pays annual premiums of at least $200,000 for each line of insurance purchased from the captive, or at least $75,000 for any line of coverage in excess of $25 million in the annual aggregate ( e.g. , general liability insurance).9

Basic Federal Tax Treatment: Definitions
Originally, the IRS challenged captives on a theory known as the “economic family.” But the service lost these cases continuously, ending with its last effort in United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001). After giving up on its “economic family” argument, the IRS began to concentrate on the definition of “insurance,” which was defined by the U.S. Supreme Court when it held that “[h]istorically and commonly, insurance involves risk shifting and risk-distribution.”10

Risk Shifting — Risk shifting occurs when risk is transferred to an insurer in return for the payment of premiums. The insureds can be related. However, there is no insurance when a subsidiary insures its parent.11

Risk Distribution — The primary IRS challenge is now on “risk distribution.” Risk distribution is the method of reducing the danger of potential loss by spreading costs throughout a group.12 In other words, is the captive issuing a sufficient number of policies to different insureds? Risk is spread over some undefined number of claims and exists so long as one of the two following safe harbors is met. 1) At least 50 percent of the risks underwritten are for unaffiliated third parties.13 This can be accomplished by finding quality reinsurance risk to underwrite. Reinsurance is typically set up among several captives by the captive insurance consultant. This is called a “risk pool.” 2) Underwriting 12 or more separate insureds, even if they are affiliated with the captive (disregarded entities do not count).14

Life Insurance — A captive cannot issue life insurance.15 A life insurance company is defined under I.R.C. §816. It may buy life insurance related to risks it insures. A good example is key employee life insurance when it can be shown that the loss of the key employee would adversely affect the business. The life insurance may not be the main goal of the captives.

Exit Strategies — The captive can be liquidated. Upon distribution of the captive’s assets to the shareholders, they may be entitled to long-term capital gain recognition. The stock of the captive can also be sold to a third party, also creating long-term capital gain treatment.

IRS Requirements
In addition to fitting within the definition of an insurance company, all captives must meet the following criteria in order to be taxed as an insurance company.16 The captive is regulated as an insurance company in whatever venue it does business; an adequate amount of capital is present within the captive; the captive is able to pay claims; the captive’s financial performance is adequate; the captive’s business operations and assets are kept separate from the business operations and assets of its shareholders; and the captive maintains separate financial reporting from the parent and any affiliated companies.

Additionally, the captive must also operate like an insurance company.17 The insured parties truly face hazards. Premiums charged by the captive are based on commercial rates. The risks are shifted and distributed to the captive, since the entities are commercially and economically related. The policies contain provisions confirming that the covered risks may exceed the amount of premiums charged and paid. The validity of claims is established before payments are made. The premiums of the operating subsidiaries are determined at arm’s length. The premiums are pooled so that a loss by one operating subsidiary is borne, in substantial part, by the premiums paid by others. The captive and its insureds conduct themselves in all respects as unrelated parties would in a traditional relationship.

In order to take advantage of I.R.C. §831(b), the entity must be a regular C corporation, not an S corporation or a partnership for tax purposes.

“Controlled groups” are defined under I.R.C. §1563(a) — except that “more than 50 percent” shall be substituted for “at least 80 percent” — and shall be treated as one for purposes of calculating the premium limits set forth in I.R.C. §831(b)(2)(A).

Foreign domiciled insurance companies are subject to reporting requirements, the passive foreign investment company tax under I.R.C. §1297, and federal excise tax on premiums paid under I.R.C. §4371. Captives usually make an election under I.R.C. §953(d) to be taxed as a U.S. domiciling entity to avoid these problems.

There are some unique elements of the Florida bill. A “special purpose” captive may only insure the risks of its parent. The Florida captive must have at least three incorporators, at least two of whom must be Florida residents.18 At least one member of the captive’s board of directors must be a Florida resident.19 The coverages may not include workers’ compensation or employer’s liability, life, health, personal motor vehicle, and personal residence insurance.20 The Florida captive must hold at least one board of directors’ meeting each year in Florida,21 and it shall maintain its principal place of business in Florida.22 At least 35 percent of the Florida captive insurance company’s assets must be managed by an asset manager domiciled in Florida.23 Additionally, unlike many of its competitors, including mostly offshore companies, Florida requires a substantial background investigation of the individuals and the company, including financial backgrounds, criminal backgrounds, and financial stability. They even suggest that an officer or director may not be qualified if previously involved in an insolvent business.

Some Florida requirements not found in most offshore venues include24 evidence of the amount and liquidity of the proposed Florida captive’s assets relative to the risks to be assumed; evidence of adequate expertise, experience, and character of the person(s) who will manage the company; evidence of the overall soundness of the company’s plan of operation; evidence of adequate loss prevention programs of the company’s parent, member organizations, or industrial insureds; and any other factors relevant to Office of Insurance Regulation (OIR) in ascertaining whether the company will be able to meet its policy obligations.

There are some limitations not found in offshore venues. For example, a pure Florida captive insurance company cannot insure any risks other than those of its parent, affiliated companies, controlled unaffiliated businesses, or a combination thereof.25 Thus, it does not appear to permit a risk pool as described. An industrial insured Florida captive insurance company cannot insure any risks other than those of the industrial insureds that comprise the industrial insured group and their affiliated companies.26 Finally, a special-purpose Florida captive insurance company can only insure the risks of its parent.27

While a regulatory review on an on-going basis is meant to be substantially reduced compared to a public insurance company,28 There are still annual reporting requirements and regulations that must be complied with, as with any other insurance company. For example, if a Florida captive discounts its loss reserves, it must file an annual actuarial opinion issued by an independent actuary.29 The OIR may disallow such discounting. An annual audited financial statement may be requested by the OIR. It must be prepared in accordance with OIR accounting rules, not generally accepted accounting principles (GAAP), and OIR may require continuing review of operations. Additionally, a captive may not pay a dividend out of capital or surplus in excess of the listed limitations without the prior approval of the OIR.30

Many of the members of the legislature felt that this new act would also help create jobs. The Florida captive must hire professionals like actuaries, risk managers, investment managers, and have its officers and directors in the state of Florida, along with its business address.

In conclusion, while Florida has tried to align its captive insurance company statute to compete with other states, it falls short on several points. More importantly, it does not come close to competing with offshore venues which have substantially lower regulatory requirements and asset protection characteristics that are very valuable to smaller businesses that desire to take advantage of them.

1 Fla. Stat. §628.909(1).

2 See Adkisson, Captive Insurance Companies, Ch. 5 (1st ed. 2006).

3 Fla. Stat. §628.907(1)(a).

4 Fla. Stat. §628.908(1)(a).

5 Fla. Stat. §628.907(2)(a).

6 Fla. Stat. §628.907(1)(b).

7 Fla. Stat. §628.908(1)(b).

8 Fla. Stat. §628.905(c).

9 Fla. Stat. §628.901(8).

10 Helvering v. Le Gierse, 312 U.S. 531 (1941).

11 Stearns-Rogers Corporation v. U.S., 774 F.2d 414 (1985); Beech Aircraft Corp. v. U.S., 797 F.2d 920 (1986); Gulf Oil Corporation v. U.S., 89 T.C. No. 70 (1987).

12 Commissioner v. Treganowan, 183 F.2d 288 (2d Cir. 1950).

13 Rev. Rul. 2002-89 2002-2 C.B. 984 and 2002-90, 2002-2 C.B. 985.

14 Rev. Rul. 2005-40, 2005-2 C.B. 4.

15 I.R.C. §831(a).

16 See Adkisson, Captive Insurance Companies, Ch. 5 (1st ed. 2006).

17 See Rev. Rul. 2002-91; Ocean Drilling & Exploration Co., 988 F.2d 1135 (1993).

18 Fla. Stat. §628.910(3).

19 Fla. Stat. §628.910(7).

20 Fla. Stat. §628.905(1).

21 Fla. Stat. §628.913(2)(b).

22 Fla. Stat. §628.913(2)(c).

23 Fla. Stat. §628.918.

24 See Fla. Stat. §628.905(3).

25 Fla. Stat. §628.905(1)(a).

26 Fla. Stat. §628.905(1)(b).

27 Fla. Stat. §628.905(1)(c).

28 See Fla. Stat. §628.911.

29 See Fla. Stat. §628.912.

30 See Fla. Stat. §628.908(3).

Domenick R. Lioce was admitted to The Florida Bar in 1979, and he holds undergraduate, graduate, and legal degrees from Florida State University (B.S. 1973; M.A. 1978; J.D. 1979). He has been a certified public accountant in Florida since 1976. Lioce is a member of the Florida Institute of Certified Public Accountants; past-chair of The Florida Bar Tax Section board of directors; president of the Florida chapter and president-elect of the national association of the American Association of Attorney-CPAs; and a member of the board of directors of the Florida Lawyers Mutual Insurance Company.

This column is submitted on behalf of the Tax Law Section, Joel David Maser, chair, Michael D. Miller and Benjamin Jablow, editors.