As a business grows and matures, its owners may look for additional means to grow revenue and boost business wealth. A common approach is to start or acquire an additional business that serves the core business. This is often described as vertical integration, and it is often effective because a supplier or service provider is already making a profit serving the parent company. Also, the parent company is “staying close to home,” and usually not straying too far from its core competencies.
As an example, a manufacturer may choose to purchases or start a business within its own supply chain. Not only does this give the manufacturer greater control of its supply chain, it also enables the manufacturer to earn additional profits. Another benefit is that the business owner may gain better control of his or her risks, including the risk of a key supplier folding or choosing to sell to a competitor.
Clearly, this business move is not without risk. In some cases, the manufacturer may be ill-prepared to run another company. The owners may not understand the pitfalls that their supplier has already overcome. Their supplier may have expertise or sourcing advantages that the manufacturer is unable to replicate. And, choosing to compete with a supplier may embolden them to “pull out all stops” to support a business’ competitor. A lot can go wrong.
Is There A Low Risk AND Low Effort Way To Set Up Another Profitable Business?
Actually, there is. A successful business can turn its risk management into a separate business. Furthermore, a well-run risk management business can function as an additional profit center. To achieve this break-through result, the business owner implements Enterprise Risk Management (ERM) and sets up and owns an insurance company, specifically, a captive insurance company (CIC). Captive insurance companies are a separate company, and the form the backbone or chassis of ERM for small and mid-size businesses.
Implementing ERM with a CIC can be a low risk endeavor because the business can choose to keep existing third party insurance coverage intact and utilize the captive to cover gaps in its existing risk profile. ERM for small and mid-size businesses is most effective when it blends third party commercial insurance coverage with insurance coverage provided by the CIC. In this manner, a business owner is able to enjoy a comprehensive blanket of protection.
Also, by working with an experienced and proven captive manager, a business does not need expertise in operating its own insurance company. The captive manager oversees and coordinates most all of the work. The business owner is able to own his or her own risk management business, while capable hands carry-out set up and operations on the owner’s behalf.
What Is A Captive Insurance Company?
Simply put, 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, and captives are generally formed to insure the risks of a business, group of businesses and related or affiliated third parties.
What Are The Benefits Of Enterprise Risk Management With A Captive Insurance Company?
First, the parent company is able to benefit from a far more robust, holistic approach to risk management. Specifically, the parent company or companies can now formally insure risks that may have previously been uninsured or under-insured. The parent company can also insure deductibles where it has third party commercial insurance in place.
Second, the overall (or aggregate) wealth of one or more businesses with ERM and a CIC in place is almost always higher – significantly higher – than the overall wealth of companies without ERM and a CIC. This occurs for two primary reasons. First, the parent company takes an expense as it pays its insurance premium to its captive. This lowers the parent companies taxable income. And, the captive can make an 831(b) election and be taxed at a zero percent (0%) rate on its underwriting profits, provided the premiums it receives are less than $1.2 million annually. Second, the captive is able to earn a return on its reserve pool (or assets). And, the captive’s asset pool has been amassed with pre-tax dollars, enabling asset growth on a larger starting base.
How Can Starting Another Business Significantly Grow Wealth?
Adverse events are going to occur whether or not a business has ERM in place. Businesses with a captive 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). Hence premiums paid to the captive are in effect a “transfer of wealth” and are protected from the parent company’s creditors and lawsuits. For this reason (tax savings and reserve accumulation), ERM with a CIC is quite often a successful and profitable “second business.” Over time, ERM with a well- structured captive can often double a business owner’s wealth.