Imagine if your business could take control of its own insurance program—reducing costs, tailoring coverage to your exact needs, and turning premiums into long-term financial assets. What if, instead of sending premium payments to a commercial insurer, you could keep those dollars working for you, building reserves and providing enhanced protection from risks that traditional insurers overlook?

For business owners—especially those running successful, growing enterprises—insurance is more than a line item on a budget. It’s a tool that can be optimized for both protection and financial efficiency. Captive insurance offers an innovative strategy: allowing businesses to self-insure through a company they own and control, capturing underwriting profits, and creating a flexible, long-term risk management vehicle.

Captive insurance can be transformative—but it’s not a “set it and forget it” strategy. Establishing and operating a captive requires a disciplined approach to compliance, governance, and risk management. This whitepaper will explain how captive insurance works, highlight the types of businesses best suited for this approach, and explore ways to ensure your strategy is both compliant and effective.

What Is Captive Insurance?

Captive insurance is an arrangement where a business creates its own licensed insurance company to insure its risks. The captive is wholly owned and controlled by its parent company or affiliated businesses. Unlike traditional insurance, captives allow businesses to:

• Customize coverage for unique risks

• Gain control over claims handling and policy terms

• Access reinsurance markets directly

• Capture underwriting profits and invest premium reserves

By underwriting its own insurance, a business can achieve significant cost savings and improve risk management, especially when commercial insurers offer limited or expensive options.

Understanding 831(a) and 831(b) Captives

The Internal Revenue Code (IRC) provides specific tax rules for insurance companies, including captives:

• Section 831(a): Captives taxed under this section are treated like C-corporations, paying tax on both underwriting profits and investment income at standard corporate rates. This is common for captives with annual premiums exceeding $2.85 million (2025)(1).

• Section 831(b): Known as the “micro-captive” provision, this allows small captives (less than $2.85 million in annual premiums) to elect to be taxed only on investment income, excluding underwriting profits. While this offers tax advantages, it also subjects the captive to added IRS reporting requirements and heightened audit scrutiny.

  
  

Both structures have their place. Larger captives or those expecting significant underwriting profits may opt for 831(a), while smaller captives seeking tax efficiency may choose 831(b) but only with careful compliance.

How Reinsurance Pools Fit In

One key aspect of captive insurance is risk distribution. To qualify as a true insurance company under IRS guidelines, a captive must spread risk across multiple insured parties or policies. This can be challenging for single-owner captives.

Reinsurance pools solve this problem. These are collaborative arrangements where multiple captives pool their risks together and share claims exposure. By participating in a reinsurance pool, your captive:

• Achieves broader risk distribution (a key compliance requirement)

• Gains additional layers of protection against large losses

• Strengthens its financial footing by sharing catastrophic risk with other participants

For example, if your captive insures your company’s cyber risk and another captive in the pool insures medical malpractice, both captives can reinsure portions of their risk with each other, helping each business meet the legal definition of an insurance company while benefiting from diversified protection.

Three Ideal Business Profiles for Captive Insurance

Captive insurance is most effective when used by businesses that face meaningful risks and are prepared to manage them responsibly. Below are three common profiles where captives shine:

1. Businesses Reducing Premiums via High Deductibles

Many businesses choose high-deductible insurance policies to lower their commercial premiums, but this exposes them to larger out-of-pocket risks. A captive can insure the deductible layer, helping the company save on overall insurance costs while maintaining protection.

Example: A regional trucking firm raises its deductible from $100,000 to $750,000, cutting its commercial liability premium by $500,000. It forms a captive to insure the $750,000 deductible layer. This strategy reduces total insurance costs while allowing the business to retain underwriting profits and build reserves.

2. Businesses Self-Insuring Specific Risks

Some companies face predictable risks that are costly to insure via traditional carriers. These businesses may already self-insure informally (covering claims directly) but can benefit from formalizing the arrangement through a captive.

Common Risks for Self-Insurance:

• Workers' compensation

• Employee health benefits

• Professional liability

• Cybersecurity breaches

• Warranty programs

Example: A chain of outpatient medical centers has historically self-insured its medical malpractice claims under $300,000. By forming a captive, the company formalizes its program, gains regulatory recognition, and invests reserves—turning liabilities into a wealth-building opportunity.

3. Businesses Insuring Uninsurable or Non-Traditional Risks

Captives allow companies to insure risks that are difficult—or impossible—to cover through traditional markets. This creates financial protection where none existed before.

Examples of Non-Standard Risks:

• Loss of a key supplier or customer

• Business interruption due to supply chain failures

• Reputational damage

• Loss of a key employee

• Regulatory changes

• Fraud and theft beyond what commercial insurers cover

Example: A specialty food distributor depends on a single supplier for 70% of its inventory. No commercial insurer will cover the risk of losing that supplier. The company forms a captive to insure against supply chain interruption. When the supplier temporarily shutters due to a labor strike, the captive pays a claim, cushioning the financial blow.

Evaluating Captive Suitability for Your Business

Setting up a captive isn’t a decision to take lightly. To determine if it’s right for you:

Compliance Considerations and IRS Scrutiny

Captive insurance arrangements are subject to strict IRS scrutiny, particularly micro-captives using the 831(b) election(2). Common red flags include:

• Premium Overstatement: Artificially inflating premiums to shift taxable income.

• Lack of Risk Distribution: Failing to spread risk adequately across policies or through a reinsurance pool.

• Non-Insurance Activities: Using captive assets for personal purposes or non-insurance business.

Due to these concerns, the IRS has increased scrutiny of micro-captive arrangements, designating certain transactions as "Transactions of Interest" and requiring additional reporting(3).

Captives must meet four essential criteria:

1. Risk Transfer: The captive assumes genuine insurance risk.

2. Risk Distribution: The captive spreads risk across multiple exposures (often aided by reinsurance pools).

3. Insurable Risk: The risk must be measurable and recognized as insurable.

4. Insurance-Like Operation: The captive must operate like a real insurance company.

Taxation of Withdrawals and Dividends

Withdrawals from the captive not tied to claim payments are generally treated as dividends and taxed accordingly. Proper recordkeeping and legal structuring are critical to avoid unintended tax consequences.

Why Professional Guidance Is Essential

Successfully implementing a captive requires collaboration with experts: insurance attorneys, tax professionals, and actuaries—who specialize in this space. Regular solvency reviews and strict adherence to regulatory requirements are non-negotiable. Overfunded captives may be required to issue dividends, and compliance failures can lead to steep penalties.

Conclusion

Captive insurance offers business owners a powerful, flexible tool to control risk, reduce costs, and create long-term financial value. Whether you’re insuring high deductibles, self-insuring specific risks, or protecting against non-traditional threats, a well-structured captive, especially one participating in a reinsurance pool, can transform your insurance strategy. Done right, it’s not just about protection—it’s about turning insurance into a financial asset that works as hard as you do.

Sources

[1] IRS Rev. Proc 2025-13

[2] Beware of IRS Initiatives against microcaptive insurance arrangements

[3] Section 831(b)

Important Disclosures

Avail and its affiliates do not provide tax or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax or accounting advice. You should consult your own tax and accounting advisors before engaging in any transaction.