How To Turn Risk Management Into A True Profit Center
Here is a captivating question. How can a small or medium-sized business turn its risk management into a true profit center?
It sounds impossible – turning risk management into a profit center. After all, risk management pays insurance premiums and covers loss control and safety programs. How could it possibly be a profit center?
Furthermore, this is not simply a question about cost containment or even cost reduction. To succeed, the business’ risk management strategy must give the business’ owners access to more money than they would have had otherwise, including completely offsetting the cost of commercial insurance and loss control programs. Clearly, a question this challenging requires some captivating thinking.
Consider the example below of a hypothetical small manufacturing business. This is merely an example. The captivating risk management approach I will outline could apply to many types of profitable small and mid-size businesses in a variety of circumstances. As the first table below illustrates, risk management is a cost center, and the business pays $210,000 in annual commercial insurance premiums and $40,000 annually is loss control and safety programs.
It’s time for some captivating thinking. The table below illustrates the exact same business with an Enterprise Risk Management (ERM) strategy in place. ERM is a discipline, whereby a business assesses all the threats it faces and develops a comprehensive risk management plan.
As part of its ERM approach, the business implements steps to reduce risk and mitigate risk. Keep in mind that insurance is a financial risk mitigation approach. As part of its ERM strategy the business owners set-up, operate and own their own insurance company, known as a captive insurance company (CIC). The CIC forms the backbone of the ERM strategy. The CIC significantly increases the business’ insurance coverage, addressing many of the risks identified in the comprehensive risk assessment.
The CIC is owned by the business’ owners. So the owners and the business effectively retain the profits in the captive insurance company. Because this CIC takes in annual premiums of less than $1.2 million, it can make an 831(b) tax election and be taxed at a rate of zero percent (0%) on its underwriting profit. In the illustration below, this results in $460,600 in annual tax savings. This assumes a combined federal and state tax rate of 47%.
Finally, the table below illustrates how ERM with a CIC turns risk management into a true profit center that – in effect – pays the business’ owners or increases the total wealth of the owners. The ERM Program results in $460,600 in tax savings. The tax savings generates an estimated $13,818 in investment income (assumes 5% return and 3% after tax return). The CIC pays $75,000 to operate, renew its actuarial pricing of policies, issue policies, renew its insurance license, conduct an annual audit and purchase reinsurance for its policies. As we have already established, the business spends $210,000 on commercial insurance. As part of its ERM strategy, the business is investing $40,000 in loss control and safety programs.
As can be seen, ERM with a CIC produces a dramatic result. This business’ risk management strategy was a drain on the business, costing it $210,000 annually. With ERM in place, the business’ risk management program created $149,418 incremental wealth to the business owners after offsetting: the cost to operate the CIC, the cost to reinsure the CIC, the total cost of commercial insurance, and the cost of implementing a loss control program. Captivating Thinking enables successful business owners to convert risk management from a cost center into a powerful profit center.