Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How the Ultra-Wealthy Use Captive Insurance for Tax Efficiency
Transcript
- Lucas: So you've got a family-owned commercial real estate portfolio — say, fifteen strip malls across the Southeast, collectively worth about $120 million. Their property insurance premiums are running $600,000 a year, and the carrier keeps hiking rates because of hurricane exposure in Florida. Luna: Right, and they're paying for coverage they barely use. No major claims in years, but the premium just goes up. Lucas: Exactly. So what they do instead is form a captive insurance company — a small, privately-held insurer that they own. They put that $600,000 into the captive as a premium, and the captive pays claims directly. The family gets a tax deduction for the premium, and if claims are low, the money grows inside the captive, tax-deferred. Luna: And the captive is a separate legal entity, so the premium is a legitimate business expense. The IRS treats it as insurance, not a self-funded reserve. Lucas: That's the key. The IRS has requirements to treat it as insurance for tax purposes. One is risk distribution — the captive can't just insure one property. It needs a pool of risks, ideally unrelated. In practice, many families use a group captive where multiple businesses pool their risks, or they use a 'rent a captive' structure. Luna: So the family in our example — do they use a single-parent captive or join a group? Lucas: Single-parent, but they diversify by insuring multiple properties and some unrelated third-party risks. The IRS has an '80/20 rule' — at least 20 percent of the premiums must come from unrelated parties to avoid reclassification. So they might insure a few properties owned by friends or business partners. Luna: And the tax benefit is substantial. They're deducting the full premium, but the captive only pays tax on its investment income if it elects under Section 831. Lucas: Right. Section 831 captives can elect to be taxed only on investment income, not on underwriting profit. That's huge. The captive can accumulate reserves for future claims and only pay tax on what it earns from investing those reserves. The premium itself flows through tax-free at the captive level. Luna: But there's a cap on that election, right? The annual premium can't exceed a certain amount. Lucas: Yes, as of 2026, the 831 election applies to captives with annual premiums up to $2.3 million, indexed for inflation. For our real estate family, $600,000 is well within that. And even if premiums exceed the cap, they can still use a captive — they just don't get the tax-free underwriting profit treatment. Luna: So what do they typically insure through the captive? Beyond property coverage. Lucas: Liability, workers' comp, cyber risk, even warranty programs. Anything that commercial insurers either won't cover or charge a high premium for. One popular use is directors and officers liability for the family's operating companies. Commercial D&O is expensive; a captive can offer similar coverage at a lower cost because it's the family's own money at risk. Luna: But if a catastrophic claim hits — say a hurricane destroys two strip malls — the captive has to pay. If the reserves aren't enough, the family still has to cover it. Lucas: That's why most captives buy reinsurance from commercial carriers for large losses. The captive takes the first layer — say, the first $250,000 per claim — and the reinsurer covers excess. The family still gets the tax benefit on the captive layer, and the reinsurance premium is also deductible. Luna: And the captive's investment income grows tax-deferred until money is paid out to beneficiaries or used to pay claims. That's a powerful wealth-building tool. Lucas: Especially because the captive can invest in a wide range of assets — stocks, bonds, private equity, even real estate. But the IRS watches for abuse. If the captive is too thinly capitalized or doesn't issue actual policies, they'll reclassify it as a self-insurance reserve and disallow the deduction. Luna: There's been a lot of IRS scrutiny on captives in the past decade. They've set up a 'Dirty Dozen' list of tax scams, and improperly structured captives are on it. Lucas: Yes, the key is to work with a qualified captive manager and an insurance attorney. You need to issue actual policies, set premium rates based on actuarial analysis, and document claims handling. If the IRS sees a pattern where premiums are always $X and claims are always zero, they'll question it. Luna: So the family in our example — after forming the captive in Vermont, one of the states with a favorable regulatory environment — they save about $400,000 a year compared to commercial insurance. And that money stays in the family's control. Lucas: And over 20 years, with investment growth, that's a significant pool of tax-deferred wealth. It's not just about saving on premiums — it's about creating a family-owned insurance company that can become a multigenerational asset. Luna: Speaking of which — a quick honest thing. We don't run ads on this show, and that's intentional. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Lucas: Yeah, it's a small group, but it keeps the whole podcast network ad-free. If these money conversations have helped you think about a decision differently, that link is there. No pressure at all. Luna: And we appreciate everyone who listens. It's what makes this possible. Lucas: Back to captives — one more consideration: the captive can also be used to insure risks that commercial insurers won't touch at any price. For example, a family-owned manufacturing business might insure against supply chain disruptions from a specific supplier. That's not something you can easily buy on the open market. Luna: So it's a form of risk management tailored to the family's specific exposures. And because the captive is owned by the family, they control the underwriting criteria and claims process. Lucas: Exactly. That control is a big part of the appeal. For ultra-wealthy families, it's not just about taxes — it's about having a tool that aligns their risk appetite with their financial structure. And if done right, the IRS respects it. Luna: So for families with $10 million or more in annual revenue, a captive is worth exploring. But it's not a DIY project. Lucas: Absolutely not. You need a team: captive manager, actuary, insurance attorney, and a tax advisor who understands Section 831. But for families that already have substantial premiums and a desire to keep more wealth inside the family, it's one of the most effective structures available. Luna: Next time we'll look at how captives can be used in combination with family limited partnerships for estate planning — a two-for-one strategy. Lucas: Looking forward to that. For now, if you're curious about captives, start with your CPA and ask whether your current insurance costs could be captive-eligible. Luna: Thanks for joining us on The High Net Worth Podcast. Lucas: We'll see you next time.