Too Close To Home – The Case For Business Interruption Insurance

CIC Services is headquartered in Knoxville, TN in the foothills of the Smoky Mountains.  East Tennessee is a beautiful place and natural disasters are usually few a far between.  The Cumberland Plateau to our west usually pushes massive storms and tornados to the north or south of us, and our elevation usually minimizes flooding.  Also, the Smoky Mountains and Carolinas to our east protect us from any hurricanes or storms in the Atlantic.

All that changed this year with a drought, unlike any of us have ever seen who have lived here most of our lives.  The drought has spawned enormous wildfires in East Tennessee and the Carolinas, forcing the evacuation of the towns of Gatlinburg and Pigeon Forge, two thriving tourist destinations in the Smokies.  The New York Times reported, “Gatlinburg Wildfires Force Evacuations: It Was Like Driving Into Hell.”  More than 14,000 people were evacuated.

This is the busy season for so many business owners in the area, as Fall leaves changing colors and Christmas in the Smokies draw thousands of visitors to lodges, restaurants, candy shops, holiday stores, gift shops, collectibles dealers, putt-putt golf and a myriad of other attractions.  And hundreds of business owners are facing difficult questions and decisions.  How long will their business be closed?  How will they pay their employees?  How will they survive the slow season next year without a strong busy season this year?

It’s for this reason that most of the Captive Insurance Companies (CICs) we manage have insurance policies in place to cover business interruption, and these policies specifically compensate for lost revenue.  A CIC is particularly well-suited for business interruption, because revenue replacement policies are often expensive or difficult to obtain on the commercial market.  Furthermore, premiums paid to commercial insurers are a sunk cost.

With a CIC arrangement, business owners are able to own their own insurance company.  Small CICs as defined by IRC 831(b) can elect to be taxed at a rate of 0% on their underwriting profits, enabling them to accumulate significant loss reserves for the future.  When a crisis arises, a business owner with a CIC can essentially address this year’s problem with prior years’ taxes (or what would have been prior year taxes), provided the crisis is insured by the owner’s CIC.  Imagine the peace of mind owning a Captive Insurance Company could provide!

What Is A Captive Insurance Company?

A captive is a unique and REAL casualty insurance company.  It includes its own corporation, insurance license, reserves, policies, policyholders, and claims.  It is a formal way for business owners to self-insure, and captives are generally formed to insure the risks of business owners and related or affiliated third parties.

There are many risks that all businesses regularly face and informally self-insure.  It’s worth noting that businesses informally self-insure with after tax dollars, meaning that a businesses’ “rainy day fund” is usually comprised of retained earnings that have already been taxed.  With a captive in place, businesses can formally insure risks not normally insured by third party insurers.  Premiums are paid from the parent company to the captive with tax deductible or pre-tax dollars, and can accumulate tax-free as reserves of the captive (up to $1.2 million annually – $2.2 million in 2017).  Reserves can be transferred into virtually any other type of asset (some domiciles have restrictions).