Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Captive Insurance for Tax Deductions and Risk Transfer
Transcript
- Lucas: When you run a family office, one of the biggest line items on the annual budget is insurance. Property, liability, directors and officers, cyber — it adds up fast. But a growing number of ultra-wealthy families are deciding to stop paying those premiums to commercial carriers and instead pay them to themselves. Luna: You're talking about captive insurance. It's been around for decades but it's getting a lot more attention now. Lucas: Exactly. A captive is basically a licensed insurance company that the family owns and controls. They use it to insure their own risks — or sometimes risks of related entities — and the premiums they pay are tax-deductible as a business expense, just like buying a policy from AIG or Chubb. Luna: So instead of the premium going out the door forever, it stays inside the family's ecosystem. And if claims are lower than expected, that profit stays in the captive too. Lucas: Right. And there's a specific tax structure that makes this especially attractive for wealthy families: the 831 election. Under Section 831 of the tax code, a captive that writes no more than $2.3 million in premiums per year — that's the 2026 inflation-adjusted limit — can elect to be taxed only on its investment income, not on its underwriting profit. Luna: So the underwriting profit accumulates tax-free inside the captive? That's huge. Lucas: It is. Let me give you a concrete example. I spoke with a family office in the Midwest that owns a portfolio of commercial real estate — strip malls, office buildings, about $200 million in total value. They were paying roughly $1.8 million a year in commercial property and liability insurance. They set up a Vermont-based 831 captive and now pay themselves about $1.2 million in premiums. The other $600,000 they still buy from the commercial market for catastrophic layers. Luna: So they saved $600,000 a year in premiums right off the bat, plus the $1.2 million is sitting in their own captive earning investment returns. Lucas: Exactly. And those investment returns inside the captive are taxed at the corporate rate only — currently 21% — but if they invest in municipal bonds or certain tax-advantaged assets, they can get that down even further. Over five years, that reserve pool can grow to $7 or $8 million if they have low claims. Luna: But the IRS has rules to prevent abuse. You can't just have a captive that insures only your own family's risks and call it insurance. Lucas: That's the key point. The IRS requires something called 'risk distribution' — meaning the captive needs to insure a pool of independent risks so that no single loss event wipes out the reserve. For a family office captive, that often means the captive insures not just the family's own entities, but also businesses owned by other families or trusts that are not related. Some captives will write policies for 15 to 20 different entities. Luna: And the premium rates have to be actuarially sound, right? You can't just pay yourself a million dollars and call it a premium if the risk only justifies $200,000. Lucas: Right. You need a licensed actuary to sign off on the rates. And you need an independent captive manager. The IRS takes a hard look at captives, especially under the 'evergreen contract' rule — if the captive can cancel the policy at any time, it's not really insurance, it's just a savings account. Luna: So this isn't a DIY strategy. You need lawyers, actuaries, managers. Lucas: Absolutely. But for families with at least $50 million in insurable assets, the setup costs — typically $50,000 to $100,000 to form the captive and maybe $30,000 a year in ongoing management — are easily outweighed by the savings. And it's not just cost savings. Captives also give families control over claims handling and risk management. They can invest in loss prevention, which directly benefits their own bottom line. Luna: And that's actually a perfect example of why we keep these conversations ad-free. The whole point is to help our listeners make smarter decisions, not to sell them something. If you find value in what we do, you can support the show at buy me a coffee dot com slash fexingo. It keeps us independent. Lucas: Yeah, and we appreciate that. So back to captives — one other angle is that captives can also be used for wealth transfer. If the captive is structured properly, the shares can be given to younger generations over time, and the future growth of that reserve pool passes to them outside the estate. Luna: That's interesting because you're essentially moving the insurance premium — which was a consumption expense — into an asset that can appreciate and be transferred. Lucas: Right. But you have to be careful. The IRS has anti-abuse rules around captives used primarily for estate planning. The captive has to have a real insurance purpose, not just be a tax dodge. That's why the risk distribution and actuarial soundness are so critical. Luna: So what are the most common mistakes families make when setting up a captive? Lucas: The biggest one is underestimating the regulatory burden. Captives are regulated by the state where they're domiciled — Vermont, Delaware, the Cayman Islands, Bermuda are the big ones. You have to file annual financial statements, get audited, and pay premium taxes. In Vermont, the premium tax is about 0.4% of written premiums. It's manageable, but it's not nothing. Luna: And the second mistake? Lucas: Not having enough capital. The captive needs to hold enough reserves to pay claims. If a family tries to capitalize it with just the minimum, say $250,000, and then writes a $2 million policy, that's a red flag. Most regulators expect at least $500,000 in capital and surplus. Luna: And what about the current environment in 2026? Are more families looking at captives now? Lucas: Yes, because commercial insurance rates have been rising steadily — property insurance alone is up maybe 15 to 20 percent over the past two years in some regions due to climate risks and inflation in construction costs. So the savings from captives are bigger than they were five years ago. Luna: And with interest rates still relatively high — short-term rates around 4.5 percent — the investment income on the reserve pool is decent too. Lucas: Exactly. The captive's cash can be invested in short-term Treasuries or high-grade bonds and earn 4 to 5 percent right now. That makes the whole structure more attractive. Plus, some families are using captives to cover risks that are hard to insure commercially — like cyber liability for a family office, or kidnap and ransom for family members who travel. Luna: It's a pretty flexible tool if done right. Lucas: It is. But I always tell families: only consider a captive if you have at least three to five years of patience. The upfront costs and regulatory complexity take time to pay off. It's not a quick tax fix. Luna: So for a family with a $50 million net worth, is it worth it? Lucas: I'd say it depends on their insurance spend. If they're paying $500,000 or more a year in commercial premiums across all lines, and they have a stable risk profile, then yes — it's worth exploring. The savings from eliminating the carrier's profit margin and overhead can be 15 to 25 percent of premiums. Luna: And if they also want to use it for estate planning, they need to be even more careful. Lucas: Absolutely. The estate planning angle is a secondary benefit, not the primary reason. If the IRS sees a captive that is thinly capitalized and only insuring the patriarch's assets, they'll recharacterize the premiums as non-deductible contributions to a trust — and then you have a tax problem. Luna: So the bottom line: captives are a legitimate strategy for families with significant insurable assets, but they require professional guidance and a real insurance purpose. Lucas: That's it exactly. Next episode, we'll look at how wealthy families are using private placement life insurance for tax-free growth — another structure that overlaps with captives in interesting ways. Luna: Sounds good. Until next time.