Tax Consequences—Self-Funding vs. Captive Insurance

Self-Funding Advisor

PUBLISHED ON: May 1, 2006

Obtaining tax advantages are, in most instances, not the primary reason to engage in a self-funding program involving employee benefits, although avoiding the incurrence of certain taxes (such as taxes on premiums paid to a third-party insurer) is a benefit of a self-funded or self-insurance program.

Self-funding is the opposite of commercial insurance for tax purposes and hence the provisions of the Tax Code that can facilitate a commercial insurance arrangement with concomitant tax benefits to the insured do not apply.

To the extent self-funding is viewed as a reserve for future liabilities of the entity engaging in such a program, a reserve is not tax deductible (unlike 3rd party premiums) under the premise that, in the absence of an insurance structure, with premiums paid for the issuance of an insurance contract and deductible loss reserves available to an insurer (such as a captive), only currently incurred and fixed obligations can generally be deducted for tax purposes.

Some commercial insurance arrangements, such as retrospectively rated insurance arrangements, are like self-insurance arrangements. Most insurance arrangements, however, differ from self-funding in substantial ways, including tax consequences.

As noted above, while certain tax costs are avoided with a self-funded program, the advantages of tax deductions for premiums paid to a commercial (or captive) insurer are lost, along with tax deductible loss reserves, except for plans that choose instead to self-insure through a captive which would qualify as an insurance company for purposes of the Internal Revenue Code. It could also be noted that a well set up captive, in addition to certain tax advantages, can avoid the unpredictable ramifications that can exist with self-funding.