Most small and medium size businesses are under-insured. Today, businesses face far greater risks than similar businesses faced in the past. In addition to common risks like theft, fire and general liability, there are a host of other risks that businesses face that are specific to their industry and exacerbated by shifts in technology, regulations and the legal system.
Lawsuits are far more common in the current business climate, and lawsuits can come from both outside or inside a company. Businesses face more and more regulations, and it’s not uncommon to read a news article about a business crippled or closed down by regulators. Many businesses today also face cyber risks and threats to data security and IT systems. As if that is not enough, terrorism in the U.S. now poses a legitimate threat to businesses. And, many of these “new” risks are not covered by typical third party insurance policies. These types of coverage often require additional policies that are often very expensive.
What Is Informal Self-Insurance?
The result is that many business owners choose to take the risk. “Taking the risk” can also be described as informally self-insuring risk. There are many reasons that business owners under-insure the risks their business faces.
One of the biggest reasons is that insurance premiums paid are a SUNK COST.
After a year or two or three or ten or twenty with no claims, a business is left at the end of the term with nothing to show for it. It’s that simple, there is nothing to show for all those insurance premiums paid… except for peace of mind (but that can be fleeting too in this complex business climate).
Why Not Over-Insure For Risks?
Because insurance is a sunk cost, businesses rarely want to be over-insured. Hence, the opposite occurs, and most are under-insured for real risks that could cripple or close their business.
Is There A Better Way?
The formation of a captive insurance company can help business owners avoid being under-insured without the “sunk cost” of paying insurance premiums to a third party insurer and having nothing to show for it. The business or business owner or related parties own the captive insurance company. Hence, the premiums paid to the captive to insure risks faced by the business are not “sunk costs.” They are insurance reserves and profits owned by the captive owner.
What Is A Captive Insurance Company?
A captive is a unique insurance company. It includes its own corporation, insurance license, reserves, policies, policyholders, and claims. It is a formal way for business owners to self-insure risk, and captives are generally formed to insure primarily though not exclusively the risks of one or more businesses owned by the same or related parties.
How Does a Captive Insurance Company Work?
A captive primarily insures its parent company or related companies. Hence, the parent company is able to purchase insurance from its captive, and it can insure risks that third party insurers will not insure or risks where third party insurance cost is unaffordable.
Premiums are paid from the parent company to the captive with pre-tax dollars. The captive can invest its assets mostly as its owners choose (some domiciles have restrictions).