Captive Insurance, Buyer Beware
Closely-Held Insurance Company structures, known as "CHICs", are sometimes used to purchase life insurance outside the estate of the business owner with what amounts to pre-tax dollars. This should not be the primary focus of the captive, but is something that can be done with a portion of the captive's accumulated assets.
If the primary purpose of the captive is to buy life insurance, or act as the conduit for the pre-tax purchase for life insurance, or if life insurance becomes the significant asset of the captive, there is a risk that the arrangement will not be considered a bona fide captive arrangement but will instead be treated as a tax shelter.
Caution that there are significant potential issues related to the Corporate Owned Life Insurance (COLI) restrictions.
There are many captive insurance promoters who attempt to persuade agents that they have special access to certain "approved" life insurance policies for captives. This is a totally false assertion. No state has "approved" a life insurance policy just for captives. Subject to the tax restrictions, a captive can invest in pretty much any life insurance policy from any company, so long as there is enough cash value in the policy to meet the reserve requirements -- taking into account all the other assets of the captive.
Likewise, many promoters and the life insurance companies that go along with them have attempted to suggest to agents that only a life insurance policy with a high initial cash value and no surrender charges can be used with captives. This is another false assertion. It also implies that the promoter is going to put 100% of the assets of the captive into life insurance, which could trigger some very bad tax consequences, including that the IRS might label the entire arrangement to be a "sham".
Some people say if life insurance is going to be used with a captive; it should only be a relatively small percentage of the captive's assets and certainly nowhere near 100%. In my talks with the IRS I get the impression that no life insurance should go into a captive.
Beware overpricing of services. In addition to the formation fee, management fee, and a percentage of the life insurance commissions, some promoters will also charge a percentage of deposits and a fee for using a shared risk pool. These fees are not commonly charged within the captive industry and may be considered excessive.
We always suggest the if you use a captive you properly file under IRS 6707A to reduce the taxes on audit. I do not know of any captive promoter that agrees with this. Google me and Google them, who do you believe?
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.