Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Captive Insurance
Transcript
- Lucas: Luna, you know how a lot of ultra-wealthy families self-insure their art collections, yachts, private jets — basically anything that costs more to insure than it's worth on paper? Luna: Right, they just eat the risk because the premiums are astronomical. But there's a more structured way to do that, isn't there? Lucas: Exactly — captive insurance. It's one of those strategies that sounds a bit arcane but is actually pretty straightforward once you unpack it. A captive is essentially a licensed insurance company that you own, and it insures risks that are either too expensive or too niche for the commercial market. Luna: If today was actually useful to you, the way these episodes stay ad-free is listener support. You can buy me a coffee dot com slash fexingo. Every contribution helps keep the conversation going. Lucas: Yeah, it's a small way to show the show matters to you, and it genuinely makes a difference. Now, back to captives — let's make this concrete. Luna: Good. So who's using captives, and what kind of risks are we talking about? Lucas: Think of a family with a $200 million commercial real estate portfolio — office buildings, retail spaces, maybe a few industrial properties. Standard commercial property insurance on that portfolio might run 1.5 to 2 percent of value per year, so roughly $3 to $4 million annually. Luna: And the captive could insure that instead? I thought captives were mostly for weird risks like cyber or product liability. Lucas: They can cover almost any risk except workers' comp in some states. But real estate is actually a sweet spot. The family sets up a captive — say in Vermont or the Cayman Islands — and capitalizes it with, hypothetically, $5 million. Then the captive issues a policy to the family's LLC covering property damage and general liability. Luna: So the family pays premiums to their own captive instead of to AIG or Chubb. But how do the numbers pencil out? The captive needs to be profitable or at least solvent. Lucas: Right. The captive charges premiums that are actuarially sound — they have to be. But because there's no broker commission, no marketing overhead, and no profit margin for a third-party insurer, the premium can be 20 to 30 percent lower. In our example, that's about $1.2 million in annual savings. Luna: And that premium money stays inside the family's ecosystem. It's not gone — it's sitting in the captive's reserve account. Lucas: Exactly. The captive invests those reserves — typically in bonds, but some captives get more creative. Over time, the investment earnings compound tax-deferred, which is the real magic. Under IRS Section 831, if the captive's annual premiums are under $2.65 million, it can elect to be taxed only on investment income, not underwriting profit. Luna: Wait — so the premium itself isn't taxed as income to the captive? Lucas: Correct. As long as the captive is properly structured and meets diversification rules — no single risk can exceed 20 percent of premiums — the underwriting profit is essentially tax-free. The investment earnings are taxed at regular corporate rates, but the bulk of the capital grows unencumbered. Luna: That's a huge advantage over just self-insuring out of pocket, where you'd lose the tax deduction on premiums you pay to yourself. Lucas: Right. With self-insurance, you can't deduct losses until they happen. With a captive, premiums are deductible as a business expense to the operating company, and the captive recognizes the income but under 831 it's exempt. It's a legal, time-tested structure — there are thousands of captives in the U.S. alone. Luna: But there are pitfalls, right? I've heard the IRS scrutinizes captives that don't have enough risk distribution. Lucas: That's the big one. The 'economic family' doctrine — if the captive only insures related entities, the IRS may argue there's no true risk transfer. You need at least 30 percent unrelated risk, or a pool of at least 12 distinct risks. That's why many family captives also insure a few unrelated businesses — maybe a friend's factory or a portfolio of rental properties they don't control. Luna: So it's not just a checkbox — you have to actually run it like a real insurance company. Claims handling, loss control, actuarial certification. Lucas: Exactly. You need a licensed insurance manager, annual audits, and a board of directors that includes independent members. It's not a DIY project. But for families with significant liquid assets and insurable risks, the setup cost — maybe $100,000 to $200,000 for legal and actuarial work — pays for itself in year one or two. Luna: What about the investment side? You mentioned captives can be creative. Are they buying private equity, real estate, that kind of thing? Lucas: Some are, but regulators generally prefer captives to hold high-quality fixed income — Treasuries, investment-grade corporates. But there's a structure called a 'captive in a box' where a third-party manager handles compliance and you can direct the investment strategy within certain bounds. I've seen captives allocate up to 30 percent to private credit or real estate debt, because the returns are higher and the captive's time horizon is long. Luna: So the captive becomes a kind of mini investment vehicle, with the added benefit of tax deferral on the earnings. Lucas: Exactly. Over ten years, the difference can be enormous. Assume a $5 million captive, annual premiums of $2 million, investment return of 6 percent. After a decade, the captive might hold $30 million versus maybe $22 million if you'd just self-insured and paid taxes on the investment gains each year. Luna: And if there's a big claim — say a fire destroys a building worth $10 million — the captive pays out, and the family still comes out ahead because they've saved on premiums and earned investment income for years. Lucas: That's the idea. Of course, if there's a catastrophic event that exceeds the captive's reserves, the family would need a reinsurance policy — which the captive can purchase from a commercial carrier. That adds another layer of cost, but it caps the downside. Luna: So captives aren't for everyone. But for families with at least $10 million in insurable assets and a long-term view, it seems like a no-brainer. Lucas: I'd say the threshold is even lower — $5 million in annual premiums can justify it. But the key is having multiple risks to pool. A family that just owns one office building probably can't diversify enough. But a family with a real estate portfolio, a fleet of vehicles, and a private foundation? That's ideal. Luna: And it's not just about saving money. It's about control — you decide what's covered, how claims are handled, and where the reserves are invested. Lucas: That's the real value proposition. Commercial insurers are increasingly restrictive — they exclude flood, earthquake, cyber, pandemics. A captive can cover exactly what the family needs. And because you own the insurer, you have a direct incentive to prevent losses. Many families use the captive to fund loss-control measures — better security systems, sprinklers, backup generators. Luna: It's almost like the captive becomes a risk management arm of the family office. Lucas: Exactly. And that's where the sophistication comes in. The best captives don't just sit there — they actively manage risk, invest prudently, and over time, they become a meaningful part of the family's net worth. Luna: Alright, I'm sold. For anyone listening who wants to explore this, where would they start? Lucas: Talk to a CPA or an attorney who specializes in captives. The Captive Insurance Companies Association has a directory of qualified advisors. And I'd recommend reading up on Section 831 — it's surprisingly readable. Then run a feasibility study. It'll cost a few thousand, but you'll know quickly whether it makes sense. Luna: And if it does, you're basically running your own insurance company. That's a pretty powerful tool in the wealth management toolkit. Lucas: It really is. And it's one of those things that, once you see it, you wonder why more families don't do it.