What Is a Micro Captive Insurance Company?

A micro captive insurance company is a formal insurance entity created and wholly owned by a business to insure its own risks. The parent company pays premiums to the captive, which in turn issues policies, transferring specific risks. For this self-insurance structure to be valid, it must involve genuine risk shifting and distribution. This allows a parent company to customize coverage for operational needs that may be unavailable or costly in the commercial market, such as high deductibles, cyber liability, or business interruption.

Core Concepts and Eligibility

The types of risks well-suited for a micro captive are often those that are difficult or expensive to insure through conventional carriers. This can include coverage for risks with low frequency but high severity, or emerging risks for which a mature commercial market has not yet developed. Examples include supply chain disruption, regulatory changes, litigation defense costs, and loss of key contracts.

To be classified as a “micro” captive, the company must meet a specific premium income threshold. For the 2025 tax year, the captive’s annual written premiums cannot exceed $2.85 million, an amount that is adjusted for inflation. This limit is the gateway to a specific tax election. Beyond the premium limit, the parent company must have legitimate business operations with authentic insurable risks.

The Section 831(b) Tax Election

The defining feature of a micro captive is its ability to make a tax election under Internal Revenue Code Section 831(b). This election alters how the insurance company is taxed. When a captive qualifies and makes this election, it is not subject to federal income tax on its underwriting profit. Instead, the captive is only taxed on its net investment income, which is the income earned from investing its reserves and capital.

This tax treatment creates a distinction between the captive and its parent company. The parent company, which pays premiums to the micro captive for insurance coverage, can generally deduct those premium payments as an ordinary and necessary business expense on its own tax return. This reduces the parent company’s taxable income. The premium income received by the captive, provided it does not exceed the annual limit, is not taxed at the captive level.

To illustrate, consider a business that pays its micro captive a $1 million premium for a legitimate insurance policy. The parent company can typically deduct the $1 million payment, reducing its taxable income. The captive receives the $1 million of premium income tax-free under the 831(b) election. If the captive then earns $50,000 in interest and dividends from investing that premium, it would only pay income tax on that $50,000 of investment income.

Qualifying for this tax treatment requires adherence to strict ownership diversification rules designed to ensure a sufficient level of risk distribution. To meet these requirements, no more than 20 percent of the net written premiums of the captive can be attributable to any single policyholder. Alternatively, the captive can satisfy diversification by ensuring that the ownership of the captive by the insured business is substantially the same as the ownership of the business itself.

The Internal Revenue Service closely scrutinizes micro captive arrangements. As of early 2025, the IRS identifies certain arrangements as “Listed Transactions” or “Transactions of Interest,” which require disclosure. These classifications often apply to structures with very low historical loss ratios. If an arrangement lacks a true insurance purpose, insures implausible risks, or has premiums that are not actuarially justified, the IRS may disallow the tax benefits.

Establishing a Micro Captive

The process of establishing a micro captive involves several distinct steps to ensure it is a viable and compliant solution for the business.

• A comprehensive feasibility study is performed to determine if a captive is an economically sound solution. The study involves a review of the parent company’s operations, risk profile, and historical loss data to project the captive’s potential financial performance and assess whether the benefits outweigh the costs.
• A detailed risk analysis is performed to identify and quantify the specific, genuine business risks the captive will insure. This analysis forms the foundation for the captive’s underwriting and is used by an actuary to determine appropriate, arm’s-length premium pricing for the policies.
• A domicile, which is the jurisdiction where the captive will be licensed and regulated, must be selected. Factors influencing this choice include initial capitalization requirements, regulatory flexibility, premium taxes, and ongoing compliance costs associated with that jurisdiction.
• A capitalization plan is developed to ensure the captive is financially sound from its inception. Regulators in the chosen domicile mandate a minimum level of capital that the parent company must contribute, which serves as a financial cushion to ensure the captive can pay claims.

Operational and Compliance Requirements

Once established, a micro captive must be managed as a legitimate insurance company, which involves several ongoing operational and compliance duties.

• An actuary must calculate the appropriate premiums for the insurance policies. These calculations must be based on sound actuarial principles to ensure the premiums are set at an “arm’s-length” rate.
• The captive must draft and execute legally binding insurance contracts between itself and the parent company. These policies must clearly define the scope of coverage, limits, and deductibles to demonstrate a true transfer of risk.
• A formal claims process is necessary. When the parent company experiences a covered loss, it must file a claim, which the captive must then evaluate and pay if valid, keeping meticulous records of all activities.
• The captive’s assets, consisting of its capital and collected premiums, must be prudently managed. A formal investment policy should be established to preserve capital and ensure the captive can meet its claim obligations.

Compliance with regulatory and tax reporting is a continuous responsibility. The captive must submit annual financial reports to its domicile’s regulators. For U.S. tax purposes, if an arrangement is deemed a “reportable transaction” by the IRS, the taxpayer must file Form 8886, Reportable Transaction Disclosure Statement, and failure to file can result in significant penalties.