Funding Captive Insurance Premiums in a Tight Economic Climate
The number of captive insurance companies continues to grow, because establishing and owning a captive insurance company is one of the most powerful financial vehicles available to businesses and business owners. By choosing to own their own insurance company, business owners can take better control of business risk mitigation, insure risks that are currently not insured, provide better asset protection to their business, and accumulate wealth in their captive insurance companies. Once a business owner experiences the many benefits of owning a captive insurance company, it is sometimes difficult to find the cash flow to pay annual casualty insurance premiums to the captive, particularly when economic times are difficult.
Why It Is Important to Fund Captive Premiums Annually
Captive insurance companies grow in strength and versatility as they grow reserves. Increased reserves enable the captive to: 1) insure a wider variety of risks, 2) insure larger deductibles where third party insurance is employed, and, 3) reduce or eliminate some third party insurance in the future. Furthermore, increased captive reserves can translate to increased asset protection and wealth accumulation for business owners.
Where Can Business Owners Find Funds to Pay Premiums to Their Captive Insurance Company?
Current operating profit is the most common answer. However, there are times when operating profits aren’t adequate. The following is a list of potential alternative funding sources when operating profits aren’t available due to tough economic times or other unexpected circumstances:
Option A – Reduce Take Home Compensation
Business owners can choose to reduce their take home compensation.
Option B – Reduce Profit Sharing or Qualified Plan Contributions
Business owners can choose to temporarily reduce or eliminate their qualified plan contributions. The reduction in qualified plan contributions can be deployed more effectively to fund their captive insurance premiums. First, this enables the business owner to continue to insure business risks. Second, it’s been said that “a qualified retirement plan is a great accumulation vehicle but a terrible distribution vehicle,” because when funds are withdrawn they are subject to taxation multiple times (state and federal taxes at the time of distribution and death taxes). Total loss to taxes at death is approximately 75%. It’s also worth noting that qualified plans have mandatory distribution after age 69.5.
Option C – Live on Savings and Pay Captive Insurance Premiums with Business Operating Income
Often, business owners have substantial monies in investments or savings. These investments have already been taxed. Choosing to live off savings (income that has already been taxed) can enable business owners to pay insurance premiums to their captive with business income that has not been taxed.
As an example, assume a business owner has accumulated $3 million in after tax savings. (For this example, assume interest rates and investment returns match inflation). This business owner could choose to live on $300K savings annually for 10 years. To have $300K (after tax) to cover annual living expenses, the business owner would need to earn (in most states) approximately $600K annually (pre-tax). This business owner can choose to pay casualty insurance premiums of $600K annually to a captive insurance company. In this example, the business owner accumulates approximately $ 540K annually in a well-structured captive (after administrative costs and claims). After 10 years, this results in $5.4 million in accumulated wealth compared to $3 million were the owner to continue living off the income of the business. And, most importantly, over the ten year period, the business owner doesn’t have to forfeit the added insurance coverage provided by the captive.
What Is A Captive Insurance Company?
A captive insurance company is unique. 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 risks. 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.
Some examples include (but are not limited to):
- Loss of a key account or contract
- Loss of key personnel
- Loss of a license or certification
- Loss of a sales or distribution territory
- Loss of dealership rights
- Loss of data
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).
Call us to do a model for you or to discuss whether or not a captive insurance company or additional captive insurance company is the right move for your business.
Phone – 865- 386-4920
E-Mail – Tom@CICServicesLLC.com
Web – www.CICServicesLLC.com