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Cell Captives: A Savvy Insurance Option for Some Small Businesses

Posted on: September 1st, 2018

Cell Captives: A Savvy Insurance Option for Some Small Businesses

For some time now, large businesses have been taking advantage of captive insurance companies, or captives. Basically, a captive is an insurance company established by a business to cover selected risks that the business may face.

It’s easy to see why larger firms like captives. The benefits to a firm of setting up a captive insurance company include:

  • Better risk management
  • Favorable tax treatment
  • Lower insurance costs

With a captive insurance company, successful business owners can design property and casualty coverage that is customized to their individual companies. It can also enable business owners to gain greater control over the cost of insurance and improve claims handling.

But traditionally, captive insurance companies have presented one big problem for many business owners: The expenses involved in setting up and maintaining a captive can be prohibitive for smaller companies.

The good news is that’s changing—fast. Increasingly, small and midsize businesses are looking to “cell captives” as a low-cost way to get involved in the captive insurance arena. Now, these smaller companies can share a captive insurance company but be basically responsible for their own underwriting losses and profits.

Here’s a closer look at cell captives and how to decide if they may be right for your business.

Structure of a cell captive

In 2008, the IRS issued guidance that set the stage for cell captives. A cell

captive is an insurance company composed of a “Core” (or “Parent”) and an unlimited number of “cells.”

The Core is a licensed captive insurance company. The cells are sub-insurance companies, which can be owned by business owners. The cells are segregated from each other—each one has its own distinct insurance license. This means that each cell is protected; insurance risk, liabilities, assets and all information are legally walled off from every other cell. So, for instance, the assets in one cell cannot be used to pay the liabilities in another.

There are several different ways to structure a Core and its cells. In some cases, the Core can issue shares to each cell owner. Other times, the relationship is set up using participation contracts. There also can be different capital or collateral funding arrangements. But the bottom line is that the future owner of a cell—in this case, a small- or midsize-business owner—arranges with the Core to establish a cell. The business pays premiums to the captive for coverage.

Pros and cons

There are a number of distinct advantages and disadvantages to cell captives:


  • Lower setup costs than a stand-alone captive insurance company.
  • Lower initial capital and surplus than a single-parent captive.
  • Can be a stepping-stone to a single-parent captive insurance company as it is relatively easy to make the conversion.
  • Cells are available for most lines of business such as general liability, cyberrisk and property protection.


  • The underwriting profit is tax-deferred, but you are taxed annually on the investment income at corporate rates.
  • Distributions are taxed as long-term dividends.
  • The liquidation of the cell is taxed as long-term capital gains.

All cell investments are managed the same way—conservatively. Usually, the Core investment committee makes the investment decisions. Also, the cell owner insured won’t have control over the governance of the Core. (The opposite would be true if a traditional captive insurance company were established.)

Cell captives can be used in a wide variety of ways, such as:

  • Funding the deductibles of traditional policies. A business may have a $50,000 deductible on its workers’ compensation, health insurance or commercial auto. Instead of funding that out of the cash flow of the business, the business could buy coverage from the captive to cover that deductible. It would pay premiums annually to the captive to cover those deductibles.
  • Professional liability. This would cover the errors and omissions of performing the business’s own work.
  • Writing “niche” coverage. The captive is used to write coverage the business owner feels is necessary but that is either unavailable or expensive. Example: a manufacturer needing a punitive damage policy for a defective product or manufactured drug.  

Who might benefit from a cell captive?

At the most basic level, a cell captive can become very attractive to business owners if the premiums they would pay to a traditional insurance company are higher than the cost (including the losses) of having a cell captive. And as noted, cell captives can be much less cost-prohibitive than can stand-alone captives.

That said, there are sophisticated ways some entrepreneurs are using cell captives.

Case study 1

Acme Inc. manufactures widgets and employs 268 employees. During the 12 months through April 2017, the firm paid $2.7 million in medical insurance for its employees. It was facing a renewal premium of $3.2 million. Acme decided a cell captive for the medical insurance would be a better solution for the employees. By taking the first $75,000 of the employees’ claims while purchasing additional stop loss coverage, the firm’s total medical spend for the 12-month period ended April 2018 was reduced to $2.2 million. With the great results of the 2017-2018 year, the April 1, 2018, renewal had a total maximum cost of $1.9 million. Upshot: By creating a cell captive, Acme saved over $1 million compared with what it paid in 2017 (i.e., $3.2 million vs. $2.2 million).

Bonus: That million-dollar savings allowed the firm to add more than $8 million to its value (assuming an 8x multiple of EBITDA for a potential sale). 

Case study 2

Beta Inc. created a cell captive to insure the deductibles from its traditional insurance portfolio. The company’s existing property casualty insurance portfolio was over $1 million per year. Beta redesigned its portfolio so that it increased its deductibles from $250 per claim to $25,000 per claim. That reduced the insurance portfolio premium to just over $400,000. The company took the $600,000 “savings” and paid premiums to its captive. When (or if) Beta has claims, the captive will pay the first $25,000.

Case study 3

Delta Inc. maintained a large, revolving accounts receivable balance. To minimize the risk of default, it purchased trade credit insurance from the traditional market. Although the cost was substantial, it was deemed necessary for prudent risk management.

After a few years of large premiums and few claims, Delta decided there had to be a better way. It created its own cell captive to cover this risk. Delta paid virtually the same premium as before and was able to warehouse money for potential AR losses. The company did have a few losses, but after a few years it was able to accumulate well over $2 million that otherwise would have been paid to traditional carriers.    

Take the next step

Want to find out if a cell captive is the right move for your business? Reach out to your financial professional to explore cell captive insurance companies in more detail.

This report was prepared by, and is reprinted with permission from, VFO Inner Circle.  AES Nation, LLC is the creator and publisher of VFO Inner Circle reports.

Disclosure: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.

Fusion Wealth Management is not affiliated with Kestra IS or Kestra AS. https://www.kestrafinancial.com/disclosures

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