The Best Self-Insurance Money Can Buy – ERM With a CIC Part 2

Two weeks ago, we wrote about how captive insurance companies provide “The Best Self Insurance Money Can Buy.”  A captive insurance company is the most powerful risk management and wealth accumulation tool that a business can access.  When properly employed, there is no other financial vehicle that compares.  By choosing to own its own insurance company, businesses, business owners and CFOs can simultaneously  1) improve risk management via both expanded and customizable coverage, 2) plug gaps in third party insurance coverage, 3) improve asset protection, and 4) boost wealth accumulation.

The Concept In Its Simplest Form

A business owner chooses to own a captive insurance company.

Increase Insurance Coverage – The business increases its insurance coverage.*

Keep The Money – The business owner owns the captive and owns the premiums paid to the captive insurance company.**

Almost Double The Money – The premiums paid to the captive are taxed at 0% if the captive makes an 831(b) tax election***

*Assumes keeping existing third party coverage in place or replacing third party coverage with insurance through the captive with a reinsurance (or stop-loss) policy in place.

**Assumes claims paid by the captive would have been paid from retained earnings or operating profits in the absence of a captive.

***Assumes the captive receives premiums of $2.3 million or less annually and a combined state and federal income tax rate of 40% or more.

What Is Self-Insurance? 

Self-Insurance is essentially covering any losses that occur which are not covered by third party insurance.  The business “bites the bullet” so to speak.  Most small businesses self-insure via retained earnings, operating profit, the owner’s savings or a bank loan.  Even with robust third party insurance coverage in place, small businesses still self-insure a wide array of risks.  Enterprise Risk Management (ERM) is the discipline whereby a business assets all threats and develops a comprehensive plan to address all threats.  Businesses routinely suffer adverse events that are not covered by third party insurance, and casualties can drain retained earnings, drain the owner’s savings, and in some cases, close the business.

A Better Way – Combine Third Party Insurance With Formal Self-Insurance  

By combining third party insurance with a captive insurance company, a business owner can establish a far more comprehensive and thorough risk management approach (ERM).  The captive insurance company provides formal self-insurance to the business.  Formal self-insurance via a captive insurance company can form an interlocking web of insurance coverage when combined with third party insurance.  This approach is also future focused, because the captive insurance company will accumulate additional reserves in years with low claims.  These reserves can provide more robust insurance coverage in the future and, when necessary, can be accessed by the owner (or CFO) as a war chest to address contingencies or unanticipated risks (another component of ERM).

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.  Insurance policies are issued by the captive to its parent or related companies and are actuarially priced.  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. Captives often form the backbone or chassis of an ERM program.

What If The Business Experiences A Loss?

If the business experiences a loss that is not covered by commercial insurance policies, but is insured by policies issued by its captive, it can file a claim.  Captive policies are often broadly written with fewer exclusions than commercial policies.  This helps ensure the business can get help when it needs it.  One of the great features about captives is that they enable businesses to pay for this year’s problems with prior year’s taxes (or what would have been paid as taxes in prior years without the captive in place).

What If The Business Experiences A Loss That Is Not Insured By The Captive Or By Commercial Insurance?

In most cases, the business can take a dividend from its captive to address a loss or a revenue shortfall.

What Are The Long Term Benefits Of Captive Ownership?

The first long term benefit is that the captive can provide the web of coverage described above for years.  The second long term benefit is that assets are protected from creditors in the captive.  The third long term benefit is that reserves accumulate in the captive, particularly in years with low claims.  The fourth long term benefit is that the captive receives favorable tax treatment, enabling it to almost double the owner’s wealth.  The fifth long term benefit is that the captive is able to invest and grow a larger pool of assets.  Finally, the sixth long term benefit is that when the business owners are ready to sell their business or retire, they own the captive and its wealth.  A successful captive amasses wealth for its owners that can be accessed and enjoyed in the future.  This unique ability to improve risk management and simultaneously stockpile wealth makes captives the “Best Self Insurance Money Can Buy.”