One size does not fit all in the world of
insurance coverage. The commercial
market provides packaged programs that work for some companies, but there are
limitations on the type of endorsements and
changes you can make to those policies.
If you pay $1.5 million to $2 million or more
in annual premiums and “pre-made” programs aren’t meeting your business’s insurance needs, it’s time to consider starting a
captive insurance company.
“If you want to get the specialized coverage
you need for your business, it’s better to set
up your own insurance company than to find
those coverages in the marketplace,” says
Larry Pevnick, CPA, member of the insurance and reinsurance services department at
Brown Smith Wallace LLC.
A captive insurance company is essentially
a mini-insurance business — a subsidiary
corporation established to provide your
organization with a tailored insurance program. There are many benefits to this
arrangement, including potentially significant tax savings.
Smart Business spoke with Pevnick about
captive insurance companies, how to start
one and how they can save you money.
What are the hallmarks of captive insurance?
Because you are creating your own insurance program for your own company, you
can design it to meet your specific needs. You
have greater control over your program and
coverage because you do not have to choose
a cookie-cutter offering from the commercial
marketplace. You also have more control
over claims, and your employees are more
likely to embrace safety programs and other
initiatives at your business to reduce those
claims. There is a larger incentive for cost
and loss control. If you own the company,
you are motivated to keep a clean loss record
so premiums do not increase. Every dollar
you don’t have to pay toward premiums or
claims goes back into your pocket. This is a
powerful tool for businesses in all industries,
given the right circumstances.
What companies are best suited for this?
Companies that have a lot of exposures
benefit most. For example, a $20 million manufacturing firm would have higher premiums than a $20 million accounting firm.
The first question to ask yourself is: Do we
have a high level of exposures that we are
currently not insuring? Or, is the cost of insuring those exposures out of control? A perfect
example is a contractor who must pay an
exorbitant amount for workers’ compensation coverage. A captive insurance company
can be put in place to control workers’ comp
costs. Then, the contractor can give employees safety incentives, which further controls
costs. Savings compound over time. Insurance captives are especially attractive to
closely held businesses that have an incentive to reduce costs and increase profit.
Captives are a mechanism of protecting
organizations from external exposures.
How does a captive help reduce costs and
increase profit?
The IRS gives insurance companies a tax
break that other businesses don’t get.
Insurance companies set aside reserves to
pay for claims. They can deduct the value of
those reserves before claims are paid. Most
corporations can only take deductions after
expenses are paid. If you own a captive, you can use this tax deferral technique to build
wealth. Also, captives are estate-planning
tools if you, the owner, assign a family member as the president of your ‘internal’ insurance company. As wealth is generated
through the captive by way of tax-deferral
strategies and savings due to decreased
exposures and lower premiums, that ‘profit’
can be protected while being transferred
from one generation to the next.
What are the steps for starting a captive
insurance company?
First, you should enlist a CPA or insurance
broker who is experienced in captive insurance. It is particularly important to work with
someone who understands the nuances
involved with qualifying the captive as an
insurance company for tax purposes. The
professional will review the pros and cons of
setting up a captive, and review your current
coverage. This person will get to know your
business inside and out, identifying risk exposures and areas where your insurance needs
are not being met. The adviser will review the
organizational structure of your company
and learn how and where your business
operates. Then, he or she will work with you
to design a program. The whole process can
take three to six months.
Why don’t more closely held companies utilize captives?
There’s a myth that you have to be a big,
public company to start a captive insurance
company, but this simply isn’t the case. While
candidates are generally in the $25 million to
$100 million revenue bracket, any closely
held company in any industry that pays
$2 million or more in premium costs per year
should consider a captive. Another reason
captives are not buzzed about more is
because many CPAs and business advisers
are unfamiliar with them and, therefore, do
not recommend them to their clients. This is
a highly specialized field, and starting a captive necessitates seeking out a professional
who is well versed in how to design and manage a suitable program for your company.
LARRY PEVNICK, CPA, is a member in charge of the insurance and reinsurance industry group at Brown Smith Wallace LLC. Reach
him at [email protected] or (314) 983-1247.