A common myth we often encounter is that it costs too much to set up and operate a captive insurance company. In many cases, this is a false objection put forward to justify inaction. What is really needed is a cost-benefit analysis that weighs the true cost of captive ownership against all the benefits a captive affords. In conducting such an analysis, it’s important to consider the immediate, mid-term and long-term benefits of implementing a captive program with comparison of the benefits and costs of action versus the benefits and costs of inaction. After all, inaction is a choice and the opportunity cost of inaction can be significant. Successful entrepreneurs and business owners weigh cost, weigh reward and make decisions. These are the activities that separate successful business owners from the rest.
Set-up and annual operating costs are typically 10% to 20% of the tax savings that captives can afford to business owners. For many business owners, the question is not, “Is a captive affordable.” The question is, “Would I lay down 10 to 20 cents to pick up a dollar?”
We know of no other business entity or financial vehicle that provides more total value than a captive insurance company. Not only does a captive insurance program lead to a better business model, it also affords the business owner and all businesses more comprehensive insurance coverage. The table above clearly illustrates the benefits of captive ownership as part of an Enterprise Risk Management (ERM) strategy.
Compare the status quo on the left with ERM implementation and captive ownership on the right. This illustration covers a 10 year period, assumes excess profits of $1.1 million per year and a 4% rate of investment return for both scenarios. The illustration on the right includes all costs to set-up and operate a captive insurance company. Both businesses have third party insurance coverage in place to insure core risks. The business on the right which implemented ERM with a captive insurance company has more insurance coverage and more money. In fact, over a ten year period, the business on the right has almost 80% more wealth than the business on the left. The captive approach provides numerous benefits, more insurance coverage and more money. Clearly, for many businesses considering a captive, cost should not be the determining factor.
It’s also worth noting that captive set-up and management fees are not the ideal choice when looking to cut corners. It can be penny-wise and pound-foolish to implement a captive strategy that shortchanges a solid feasibility study, uses a one-size-fits-all legal or actuarial approach or fails to develop and manage all of the documentation required to operate an insurance company that will pass muster with regulators, the I.R.S., and, should it become necessary, the U.S. Tax Court.