Over the past 20 years, many small businesses have begun to insure their particular risks through a product called "Captive Insurance." Small captives (also referred to as single-parent captives) are insurance companies established by the owners of closely held businesses looking to insure risks that are either too costly or too hard to insure through the original insurance marketplace. Excess Liability Insurance Brad Barros, a specialist in the field of captive insurance, explains how "all captives are treated as corporations and must be managed in a way in keeping with rules established with the IRS and the appropriate insurance regulator."

According to Barros, often single parent captives are owned with a trust, partnership or other structure established by the premium payer or his family. When properly designed and administered, a small business may make tax-deductible premium payments to their related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the business might be taxed at capital gains.

Premium payers and their captives may garner tax benefits only when the captive operates as a real insurance company. Alternatively, advisers and business owners who use captives as estate planning tools, asset protection vehicles, tax deferral or other benefits not linked to the actual business purpose of an insurance company may face grave regulatory and tax consequences.

Many captive insurance companies are often formed by US businesses in jurisdictions outside the United States. The reason for this really is that foreign jurisdictions offer lower costs and greater flexibility than their US counterparts. Generally, US businesses can use foreign-based insurance companies provided that the jurisdiction meets the insurance regulatory standards required by the Internal Revenue Service (IRS).

There are numerous notable foreign jurisdictions whose insurance regulations are recognized as safe and effective. These include Bermuda and St. Lucia. Bermuda, while more costly than other jurisdictions, is home to many of the largest insurance companies in the world. St. Lucia, an even more reasonably priced place for smaller captives, is noteworthy for statutes that are both progressive and compliant. St. Lucia is also acclaimed for recently passing "Incorporated Cell" legislation, modeled after similar statutes in Washington, DC.

Common Captive Insurance Abuses; While captives remain highly beneficial to numerous businesses, some industry professionals have begun to improperly market and misuse these structures for purposes apart from those intended by Congress. The abuses include the following