Imagine it’s the 1950s in Ohio: A steel company owns several coal mines that feed its furnaces, and those mines are dubbed “captive mines” because they serve only the company. To protect those mines, the company’s advisor Frederic Reiss helped set up an insurance company owned by the steel company itself – effectively ensuring the mines with the company’s own insurer. Thus, “captive insurance” was born. Fast forward to today: while you may not own coal mines, as a CPA firm owner you face your own unique risks and financial goals. The idea of creating your own insurance company might sound far-fetched, but it’s a modern strategy increasingly used in business – even by smaller firms – to manage risk and bolster long-term financial stability.
What Is Captive Insurance?
Simply put, a captive insurance company is an insurance company that you (and/or your business) own, created for the purpose of insuring your business’s risks. It’s essentially an alternative to just self-insuring informally. In a traditional setup, you pay premiums to a third-party insurer and hope for the best. With a captive, you pay premiums to your own insurance subsidiary, keeping those dollars “in the family” unless claims arise.
To further break it down: Captive insurance is an alternative to self-insurance where a business establishes a licensed insurance company for its own use and benefit. The captive focuses on covering the specific risks of its parent (your CPA firm) and can price coverage closer to cost (it doesn’t need to load premiums with profit margins for an outside insurer). In essence, you’re both the insured and the insurer. This arrangement also provides a tax benefit, since insurance premiums are a deductible business expense for the firm, whereas simply setting aside an equivalent amount as a rainy-day reserve would not be tax-deductible.
What does this look like in practice?
In the diagram above, your CPA Firm pays premiums to its Captive Insurance Co., which in turn provides Risk Coverage & Reserves for the firm. Essentially, the captive company issues insurance policies to your practice (for example, covering certain liabilities or business risks). If a covered event occurs, the captive pays out just like any insurer would. If not, the premium dollars accumulate as reserves and profit within your captive, building an asset that you ultimately control.
Is this legal? Absolutely – with proper planning. Captive insurance has been recognized in U.S. law and tax code for decades. In fact, since 1986, the Internal Revenue Code §831(b) has offered a special tax regime for small insurance companies (often called “micro-captives”). Under this provision, a qualified captive’s premium income can be exempt from federal income tax, meaning the captive is taxed only on its investment earnings.
For context, “small” currently means up to about $2.8 million in annual premium; this limit is indexed for inflation, rising to $2.8MM for 2024 and $2.85MM for 2025. In other words, if structured correctly, your CPA firm could deduct the insurance premiums paid to the captive, while the captive’s underwriting profit grows tax-deferred (only investment income is taxed annually.
Note: Proper compliance is crucial. The IRS requires that a captive operate as a real insurance company – insuring genuine risks and distributing risk appropriately – rather than a sham reserve fund. Recent IRS guidance has flagged abusive “micro-captive” setups, making it essential to work with experts to ensure your captive arrangement meets all the legal criteria, including actual risk transfer and adequate capitalization. In a well-designed captive, you get the benefits and stay on the right side of IRS rules.
Now that we know what a captive insurer is, let’s explore why a CPA practice might want one.
Why Would a CPA Firm Consider a Captive Insurance Company?
You might be thinking, “I’m an accountant, not an insurance mogul – why would I go through the trouble of setting up a captive insurance company?” It’s true that forming a captive isn’t something to do on a whim; there are costs, regulations, and ongoing management involved. However, the potential benefits can be significant, especially as a long-term strategy for a firm’s stability and the owner’s financial future. Here are some key advantages and uses of a captive for a CPA practice:
Captive Insurance: Strategic Advantages for CPA Firms
Transform risk management into a powerful financial tool for your practice
CPA Firm
Captive Insurance
Enhanced Risk Management
Customize your coverage for professional liability, cyber threats, and other practice-specific risks while maintaining control over premium dollars.
Tax Advantages
Deduct premium payments as business expenses while potentially shielding captive underwriting income from taxation under IRC §831(b).
Wealth Accumulation
Build significant reserves over time and create sophisticated estate planning opportunities through strategic captive ownership structures.
Retirement & Succession
Create a supplemental retirement fund with favorable tax treatment and leverage captive shares for key employee retention during succession.
Enhanced Risk Management
Running a CPA firm comes with risks – professional liability, cyber threats, client lawsuits, loss of key personnel, business interruption, and so on. Many of these risks are insurable on the commercial market, but some coverage might be very expensive or have exclusions, and certain risks (like reputational damage or higher deductibles) you may currently just self-insure. A captive allows you to insure select risks internally, on your own terms. For example, you might choose to raise the deductible on your commercial malpractice or office insurance (thereby lowering premiums to outside insurers) and have your captive cover that deductible layer or other “manageable” risks.
This flexibility to retain smaller risks can save money and give you tailored coverage. Over time, if claims are few, the premiums you paid stay in your captive as profit, rather than enriching a third-party insurer. And if a rainy day comes, your captive can pay out, helping your firm weather the storm without derailing your operations. In short, the captive becomes a formalized rainy-day fund with an insurance wrapper.
Tax Advantages
As hinted earlier, captives come with unique tax benefits. Premiums your firm pays to the captive are ordinary business expenses – fully deductible, just like any insurance premium. Meanwhile, the captive’s premium income can be largely shielded from current taxes if it qualifies under IRS rules. Under IRC §831(b), small property and casualty insurance companies (like many captives) can elect to be taxed only on investment income, not on underwriting income.
This means if your CPA practice paid, say, $500,000 in premiums to your captive this year and no claims occurred, that $500k could potentially sit in the captive untaxed (the captive would only owe tax on any interest or investment gains from that money).
Essentially, you’ve moved profit from your operating business (taxable as ordinary income) into a protected insurance vehicle where it grows tax-deferred. It’s a bit like a supercharged business IRA for your firm’s risks. (Of course, when the captive eventually distributes profits back to you or your shareholders, there will be tax, often at capital gains or dividend rates, which can still be advantageous.)
Wealth Accumulation & Wealth Transfer
Beyond risk and tax management, a captive can double as a wealth-building tool. If your captive operates profitably (premiums exceed claims and expenses) over the years, it can amass a significant earned surplus. Those funds belong to the captive’s owners (which could be you, your family, or even a trust or another entity you designate). By paying premiums to the captive, you’ve effectively moved wealth from your operating company into a separate entity in a legitimate, IRS-recognized manner. This opens up some clever estate planning opportunities.
For instance, you might choose to have your captive owned by your family members (e.g., a spouse, or a trust for your children) rather than by you personally. Because the captive ownership is set up for a genuine business purpose (insuring your firm’s risks), transferring value to the next generation via the captive can potentially happen without triggering gift tax or estate tax in the same way a direct cash gift would.
Retirement and Succession Planning
This is a big one for CPA firm owners thinking long-term. A captive insurance company can play a supporting role in your retirement game plan. How so? First, the accumulation of reserves in the captive over time can serve as a supplemental retirement fund. When you’re ready to retire or sell your practice, you could potentially liquidate the captive or draw dividends from it to access that wealth. Distributions from a captive might be taxed as dividends or capital gains, which often have lower tax rates than ordinary income, essentially allowing you to retrieve the money at potentially favorable rates after years of tax-deferred growth.
Additionally, captives allow for creative succession strategies. Suppose you have a junior partner or a key employee whom you’d like to reward or retain as part of your eventual exit plan. You could grant them some shares in the captive insurance company as an incentive. Down the road, when they retire or when the succession occurs, the captive can redeem those shares. The payout to your colleague would likely be taxed at capital gains rates (since it’s a redemption of stock), which could be lower than a bonus or payout taxed as regular income. It’s a win-win: you’ve given a golden-handcuff incentive to your key people and facilitated a more tax-efficient retirement payout for them.
From your perspective as the owner, having a captive can make your exit from the firm smoother – you have an additional bucket of assets to draw on, and you may even use the captive to insure any tail risks after you retire (for example, covering any potential claims from work done before you retired, which makes the transition more secure for both seller and buyer of the practice).
Future-Proofing Your Firm with Proactive Planning
At the end of the day, captive insurance is about taking control of your firm’s risk and turning potential challenges into strategic advantages. It’s a way of saying, “We’re going to expect the unexpected, and rather than simply hope nothing bad happens, we’ll prepare in a smart, financially savvy way.” This kind of forward-thinking fits naturally with what we do as CPAs – we help clients plan for the future; we should do the same for our own businesses.
Before jumping in, it’s wise to ask questions and gather information: What risks do we have that could be insured in a captive? How much might we set aside in premiums each year? What are the costs of running a captive versus the benefits we’d get? Engaging in a feasibility study with a captive consultant can provide answers. You may discover that a captive could save your firm significant money or create substantial long-term wealth, or you might find that traditional insurance is still the better route for now. The point is to explore the option rather than assuming it’s only for the “big guys.”
In Conclusion
We’ve covered a lot of ground – from a 1950s steel company’s captive mines to your 2020s accounting practice. The common thread is proactive risk management and planning for the future. Captive insurance isn’t a magic bullet or a fit for everyone, but for many CPA firms, it can be a game-changer: a retirement planning tool, a risk management strategy, and a succession planning aid rolled into one.
Remember, planning ahead is the best gift you can give your future self (and your future retirees or successors). A captive insurance arrangement is just one of many tools available to savvy practice owners. It might just be the tool that helps secure your legacy and retirement, while giving you peace of mind in the present. So, as you balance your ledgers and plan for the next fiscal year, take a moment to imagine the possibilities of being your own insurer.
