Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Insurance Deductible Financing
Transcript
- Lucas: Let's say you own a $50 million real estate portfolio — commercial properties, maybe a few luxury residential buildings. You're paying, I don't know, $400,000 a year in property and casualty insurance premiums. That's pure cost, not deductible in a meaningful way if it's personal coverage, and you have very little control over the claims experience. Luna: And you're probably not getting a lot of value out of that policy, either, unless something catastrophic happens. Lucas: Right. So a growing number of ultra-wealthy families are using something called insurance deductible financing. The basic idea: you raise your deductible dramatically — say from $25,000 to $1 million — and self-insure that gap through a captive insurance company. Luna: Which turns the premium into a deductible business expense, because the captive premiums are paid to an entity you own. Lucas: Exactly. And the premium you save goes straight to your bottom line. Let me give you a concrete example. If a family with that $50 million portfolio raises their deductible from $25,000 to $1 million, their premium might drop from $400,000 to $200,000. That's $200,000 in annual savings. Luna: And they pay the captive premium — say $150,000 — which is tax deductible as a business expense, assuming the captive is structured properly. Lucas: Right. And the captive earns investment income on those premiums, and if no claims are made, the money stays in the family's controlled entity. It's essentially a self-insurance vehicle with tax advantages. Luna: I want to pause for a second. If this episode has given you a useful way to think about your own risk management or insurance costs, we want to keep these conversations coming. The way we keep the show ad-free and listener-supported is through people like you who find value here. You can head to buy me a coffee dot com slash fexingo — that's buy me a coffee dot com slash fexingo — and toss a few bucks in the virtual jar if it's been helpful. No pressure, just gratitude. Lucas: Yeah, seconded. That support really does make a difference, and it keeps us independent. So, back to the deductible financing strategy — the IRS has taken a pretty close look at captives over the years, especially the so-called 'micro-captives' that try to claim tax benefits without real risk transfer. Luna: What's the line between a legitimate structure and one that gets you into trouble? Lucas: The IRS focuses on two things: risk distribution and risk shifting. You need to have enough unrelated risk — typically at least 12 policyholders, though the safe harbor is 12 or more — so the captive isn't just covering one family's predictable losses. And the premium has to be actuarially justified, not just an arbitrary number. Luna: So a family with multiple businesses or properties can more easily justify a captive because they have multiple exposures. Lucas: Exactly. But even a single large family office can qualify if they have diverse assets — say, commercial real estate, a private jet, an art collection, and some liability exposure from operating businesses. Each of those can be a separate policy within the captive. Luna: And the premium savings are just the beginning. The captive can invest its reserves in the family's own investments — private equity, real estate, whatever — and the growth is tax-deferred. Lucas: Right. And if the captive elects to be taxed as a small insurance company under IRS Section 831, it can exclude up to about $2.7 million in premiums from taxable income. That's the 'micro-captive' provision, and it's been heavily scrutinized, but it's still available for properly structured captives. Luna: I've seen some families pair this with a larger umbrella policy that kicks in above the captive's limit. So the captive covers the first million, and a commercial carrier covers the next $10 million. Lucas: That's a common structure. It gives you the tax benefits of the captive while still having catastrophic coverage from a major insurer. The key is that the captive has to be a real insurance company — with capital, reserves, a proper claims process, and independent directors. Luna: What's the typical setup cost? Lucas: You're looking at $30,000 to $50,000 for the feasibility study and legal work, plus ongoing administration costs of maybe $15,000 to $25,000 a year. So the $200,000 annual premium savings in my example more than covers that. Luna: And the captive itself needs to be capitalized — usually at least $250,000 in surplus. Lucas: Right. But that capital sits inside the family's controlled entity, earning returns. It's not a cost, it's just a reallocation of capital. Over time, the captive builds up reserves that can be used for other family purposes, or even distributed as dividends, though that triggers tax. Luna: One risk I've heard about: if the captive doesn't have enough claims history, the IRS might argue it's not a real insurance company. Lucas: That's a real concern. In Notice 2016-66, the IRS listed micro-captives as a 'transaction of interest' — basically a red flag. Since then, they've stepped up audits. But if you have a legitimate risk distribution — like multiple unrelated policies — and you use a qualified actuary to set premiums, you can defend the structure. Luna: So it's not for someone who just wants to dump money into a captive to avoid taxes. It has to make business sense. Lucas: Absolutely. The insurance function has to be real. I've seen families use captives to cover deductibles on their aviation policies, their property coverage, their D&O liability — and in each case, the captive is actually taking on risk. That's the core. Luna: And the premium must be reasonable relative to the risk. You can't just set a $2 million premium on a $1 million deductible and call it a day. Lucas: Right. The actuary has to show that the expected loss plus administrative costs justifies the premium. If the premium is too high, the IRS will recharacterize the excess as a dividend or contribution to capital. Luna: What about families who don't have multiple businesses? Can they still use this? Lucas: They can join a group captive — a so-called 'risk retention group' or 'association captive' where multiple unrelated families pool their risks. That's a more common structure for families with $20 million to $100 million in net worth. Luna: And the group captive still provides the tax benefits? Lucas: Generally, yes, if it's structured as a legitimate insurance company. The IRS looks at the group level, not the individual member level. So if the group has 20 members with diverse risks, that's strong risk distribution. Luna: I've also seen families use captives to cover cyber liability and data breach costs, which are hard to insure in the commercial market. Lucas: That's a great point. Cyber is a growing area for captives because commercial policies are expensive and have narrow terms. A captive can tailor coverage to the family's specific exposure — like covering ransom payments, forensic investigation, or business interruption. Luna: And because the captive earns investment income on the premiums, it can be a net positive even if there's a small claim. Lucas: Exactly. Over a five- to ten-year horizon, a well-run captive can generate significant internal returns, especially if the family is disciplined about risk management and has low claims. Luna: It's basically turning an insurance cost into a tax-advantaged investment vehicle. Lucas: That's the lens I'd recommend our listeners use. Don't think of the captive as a tax dodge. Think of it as a risk management tool that, when structured properly, happens to have favorable tax treatment. The tax savings are the tail, not the dog. Luna: So if someone is considering this, what's the first step? Lucas: Talk to a qualified insurance advisor who specializes in captives, and then bring in a tax attorney who knows the Section 831 rules. Do a feasibility study that looks at your current insurance costs, your risk profile, and what you'd gain from self-insuring the deductible. Luna: And be prepared for the IRS scrutiny, but don't let it scare you off if the structure is sound. Lucas: Right. The families that do this well are the ones who treat it like a business decision, not a tax shelter. They invest in the professional advice, they document everything, and they run the captive as a real insurance company. Luna: It's a strategy that rewards patience and discipline. Lucas: Exactly. And for families with significant assets, it's one of those strategies that can compound quietly over decades — saving premiums, deferring taxes, and building a controlled pool of capital.