Captives Can Help Businesses More Effectively Weather Losses Due To Natural Catastrophe

This week, Captive Review reported that China and Canada have both experienced billion dollar losses in 2013 as a result of natural catastrophes. Such catastrophes can be devastating to businesses, and losses almost always extend well beyond property damage.

The article also noted that this has been a “light” tornado season in the U.S.  However, “Steve Jakubowski, president of Impact Forecasting, warned that attention should be refocused on the potential for a major hurricane landfall as the US is about to enter the peak of the Atlantic Hurricane Season.”

Heavy rains caused flooding and power outages in Toronto.  Total economic losses were estimated at $1.5 Billion, but only half of losses were covered by insurance.  

The report also noted that China was rocked by three natural disasters in 2013 resulting in the loss of 225 lives and over $1 Billion in property damage.

In both cases, it’s clear that many losses will not be covered by insurance. Even if a business has excellent insurance coverage, there are often many potential economic losses that can occur as a result of a natural catastrophe. A captive insurance company can issue policies that address or fill gaps in coverage provided by third party commercial insurance.

Because a captive insurance company is owned by the parent company or by related parties or entities, its policies can be tailored to address gaps in third party coverage.  Also, its policies can be written with far fewer exclusions and exceptions that are included in most third party insurance contracts.

It’s also worth noting that by owning a captive insurance company, a business can essentially double the size of its “rainy day fund.”  The assets of a captive insurance company are effectively set aside to pay future claims and are not taxed.  Hence, a business or business owner can amass almost twice the amount of wealth as reserves in a captive versus a “rainy day fund” set aside using after tax dollars.  The result is that a business with a captive is far more prepared to deal with the aftermath of a natural catastrophe.

What Is A Captive Insurance Company?

A captive insurance company is an insurance company.  It is a C corporation and is licensed and domiciled like any large insurance company.  Captives also have their own reserves, policies, policyholders, and claims.  Owning a captive insurance company is a sophisticated way to self-insure.

What Are The Benefits Of Owning A Captive Insurance Company?

First, the parent company is able to benefit from a more robust risk management approach.

Second, the overall (or aggregate) wealth of one or more companies with a captive insurance company is almost always higher – significantly higher – than the overall wealth of companies without a captive insurance company.

Adverse events are going to occur whether or not a business has a captive insurance company in place.  Businesses with a captive in place have a much larger pool of funds to address adverse events (typically 80% to 100% more) because captive assets are comprised of pre-tax dollars.  Hence, the captive effectively acts as a legal tax shelter for the premiums received from its insured.

Premiums are paid from the parent company to the captive with pre-tax dollars, and accumulate tax-free as reserves of the captive (up to $1.2 million annually).  Captive reserves can be translated into virtually any other type of asset (some domiciles have restrictions).