Don’t Just Pay More Taxes When You Can Implement Enterprise Risk Management (And Own Your Own Insurance Company)
Over time, taxes can take a heavy toll on a business and its owners. Year after year, profits are stripped away to pay taxes often resulting in a business that is less prepared for the challenges and risks it may face in the future. The good news is that, thanks to Congress you don’t have to choose between paying taxes and having an effective and comprehensive approach to risk management.
In the mid-1980s, Congress passed legislation creating the 831 (b) “small” insurance company tax election, making comprehensive risk management, or enterprise risk management (ERM), affordable for small and mid-size companies. A small insurance company is defined as an insurance company that, among other things, collects less than $1.2 million per year in premiums. In most captive insurance company arrangements, premiums are paid by the parent company to the captive insurance company. In return, the captive provides insurance policies to the parent company. As part of a more mature approach to risk management, ERM “blends” third party, commercial insurance coverage with coverage from the CIC to address core, operational and strategic risks. This holistic approach to insurance is more robust and designed to enhance long term survivability.
The 831(b) tax election allows small captive insurance companies to be taxed at a zero percent (0%) tax rate on underwriting profit. Underwriting profit is simply defined as premiums collected less claims paid. Hence, a small business with sufficient risk could pay up to $1.2 million in premiums to its captive insurance company and the captive would pay no taxes. The captive can be owned by the business, the business owner, business owners, heirs or other related parties. Depending on claims, a captive can save up to $600,000 per year in combined federal, state and local income taxes.
Rather than simply emptying the coffers to pay taxes, it is possible for small and mid-size business owners to implement ERM and own their own Captive Insurance Company (CIC). ERM is a more mature, long term approach to risk management and business survival. A CIC forms the chassis of a small business ERM strategy, enabling the business owner to set aside future loss reserves, and obtain valuable insurance protection, with money that would have otherwise been paid as taxes.
It’s worth noting that “small” captive insurance company legislation was a bi-partisan effort passed by a Democratic controlled Congress and signed into law by Republican President, Ronald Reagan. This issue united both sides of the political aisle in America because small captive insurance companies are good for small businesses, make small business ERM possible, and help ensure long term business sustainability. As such, they are good for America.
The illustration below shows why captive ownership is so often good for businesses and good for business owners. It compares the status quo on the left with ERM implementation and captive ownership on the right. This illustration covers a 10 year period and assumes a 4% rate of investment return for both scenarios. Both businesses have third party insurance coverage in place to insure core risks. But, the business on the right which implemented ERM with a captive insurance company, has more insurance coverage and more money. In fact, over a ten year period, the business on the right has almost 80% more wealth than the business on the left. Which of these businesses is better prepared to survive the uncertainties of the business world?
Clearly, the business that implemented ERM with a Captive Insurance Company is better prepared for the future. Remember, small insurance company legislation united both sides of the political aisle in America because small captive insurance companies are good for small businesses, good for long term business sustainability, good for employment, and good for America. Don’t just pay more taxes if your business would benefit from owning its own insurance company!