Capture profits with a proprietary insurance company

An answer to lower costs, improved risk management and greater profitability
By Todd Miller, Oswald Companies

Companies with good claims experience no longer need to contribute to the cost of insuring businesses with poor loss histories.

Traditional insurance providers bundle riskier companies with less risky companies to price exposures, normalize the group’s claim experiences and avail remaining funds for healthy returns on investment. The insured policyholders, however, do not participate in these profits. Thanks to recent clarifications to tax laws, private companies now have a tool for profitably self-funding many risks, while reducing premiums paid to traditional insurance companies.

Window to profitability

In the past, many common business risks could not be cost-effectively covered by traditional insurance for privately held, closely managed businesses. These same risks had to be funded at the business owner’s expense. A recent evolution in federal tax case law, in conjunction with an updated IRS Code Section 831(b), is encouraging businesses with adequate cash flows to create a separate entity known as a captive insurance company.

Its mission is to cover these once self-funded exposures as well as fill in many insurance coverage gaps that traditional insurance policies simply cannot address. Improved risk management stemming from funding uncovered liabilities is not the only financial advantage of a well-managed captive insurance company. The combination of low overhead and special tax treatment for captives allows resulting profits to be taxed as capital gains (15%) as opposed to being treated as ordinary income, which is taxed at rates as high as 35%.

Considering that current tax laws permit a company to invest as much as $1.2 million annually in an 831(b) captive and, providing claims are minimal in a given year, investment of these pretax funds can deliver nearly a $500,000 reduction in overall annual tax liability.

Risk discretion

Better still, investment in a proprietary captive encourages a company to re-evaluate how much it relies on traditional insurance to cover exposures. For instance, a captive allows its parent company to service higher deductibles, which lowers the premiums paid to insurance carriers and results in more cost-effective coverage of risks. In other words, a captive can help reduce commercial insurance costs by encouraging its parent company to demand premiums that more accurately reflect its loss experience. The resulting savings can have an immediate bottom-line impact.

Like any insurance company, a captive is expected to invest its funds and improve its capacity for servicing claims. The IRS requires insurance companies and captives alike to properly price and diversify their covered risks. To satisfy this, individual captives must collaborate with captives of other parent companies to meet risk distribution requirements.

Working with the combination of an experienced insurance broker and a qualified captive manager is critical to assuring successful satisfaction of this requirement.

There are nearly 5,000 captive insurers worldwide. Over 80% of Fortune 500 companies take advantage of some form of captive insurance arrangement. Privately held companies are now capitalizing on the advantages, too: lower overall insurance costs; broader insurance coverage and more thorough risk management; greater profitability; reduced tax liability; and effective wealth transfer.

Considering the untold risks in today’s political environment and global economy, the option of investing in an 831(b) captive insurance company assures that the balance sheets of privately held companies will no longer be held captive by the threat of risk.

Todd Miller is a vice president at Oswald Companies, a Columbus risk consultancy and insurance brokerage with offices in Cleveland, Florida, Michigan and Minnesota. He can be reached at 614.246.8787 or tmiller@oswaldcompanies.com.

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