The IRS looks at captives and often audits them. Below are a few ideas about captives.

Successful captive programs have some or most of the following attributes. Some can be planned for at inception, while others need to be managed and realized over time. Success factors include:

1. Spread of risk with predictable losses – Successful captive owners focus on the risks they understand best – their own – and avoid the temptation to compete against commercial insurers. Successful captives also can enjoy a favorable risk spread either by having a sizeable exposure base or by incorporating a number of lines of coverage with limited correlation.

2. Good loss experience and control -- The success of a captive program can only be as good as its underlying loss experience. The best way to manage underwriting results is via targeted and rigid loss control and safety programs. Poorly managed risk programs are probably better insured by the commercial markets, no matter how over-priced the market might appear.

3. Fronting and reinsurance support -- Some captive programs cannot operate or grow without adequate fronting and/or reinsurance support. Accordingly, captive owners should look to identify fronting insurers or reinsurers with whom they can partner even if the affiliation might mean paying slightly more in any given year. It is important that the front or reinsurer be there through both good and bad years.

4. Financially stable parent(s) -- Most successful captive programs have financially sound parent(s) or insured’s that are able to pay the premium for the risk insured each year and provide additional capital for growth or to weather bad years. A captive should not be viewed as a piggy bank that can be plundered whenever a new pet project comes along or to subsidize other divisions when they experience difficulties.

5. Credible non-tax business purpose -- Successful captives are formed for true and identified risk management reasons. Those formed solely for tax reasons rarely survive over time. Tax benefits, if any, should be viewed as a bonus.

6. Strong business partners -- Since captive owners are seldom proficient in the business of insurance, very few captives are self-managed. It is crucial that a prospective captive owner retain strong business partners who possess both industry knowledge of the captive’s parent as well as a good understanding of the captive industry and how it is evolving. Business partners should be innovative and focused solely on the success of the captive itself.

7. Long-term commitment – The captive should be managed and viewed as an ongoing entity. Depending upon the lines of coverage insured, the success of a captive may not be quantifiable for five or ten years – perhaps longer. The long-term view can be difficult to master given the often-narrow business focus that demands meeting next quarter’s budget targets.

8. Positive financial return -- While many captive programs are primarily cost centers, they should be evaluated constantly against the benefits they provide to the organization as a whole. Only captive programs with positive financial returns will achieve full upper-management support and be allocated the resources needed to reach their full potential.

9. Continuous evaluation -- The captive should be evaluated regularly to ensure efficient management of retained risk across the enterprise. Often, risks originally retained by the captive may be more economically insured by commercial markets. Alternatively, risks previously deemed non-existent or minor may be ideal for the captive.

10. Be prepared for an IRS audit. Check the history of the people that want to help you with the captive. If they have sold other programs, like 412i, 419 or other abusive tax shelters do not use them.