One of the biggest single expenses that any small business owner faces is insurance costs. Rates just keep going up and up, and service seems to get worse every year. But there is a way to ditch high insurance costs while keeping your business properly covered.
And if you do it the right way, you can put extra money back into your business in the process.
I’m talking about captive insurance, which investopedia.com defines as: “a wholly-owned subsidiary company that provides risk-mitigation services for its parent company or a group of related companies.” Essentially, it’s an insurance company that you own to insure the needs of your business.
Like any insurance policy from any independent provider, the purpose is to insure your company against the ordinary business risks you face as an owner, but it also can provide monetary benefits to you and your business as well in the form of underwriting profits, additional investment income, tax savings and asset protection.
There’s no doubt that a captive insurance company will cost you money to set up, document and properly operate. You will basically pay for your own business-related claims if any. But you are already paying insurance company premiums for coverage you may not be fully utilizing or even making claims against.
Instead of that money flowing into the coffers of some big insurance company, with your own captive insurer, the underwriting profits and additional investment gains from the insurance premiums you pay are kept in-house, in the form of cash flow accumulated by your captive insurance company.
And make no mistake, the dollar amount of savings can be substantial thanks to the high levels of paid-in capital and surplus you should typically build up over time.
Your business cash flow is also improved by reducing the expenses usually associated with commercial insurance policies. As a rule-of-thumb, big insurance companies typically reserve about 60 percent of the insurance premiums you pay every year to cover potential loss payouts.
Meanwhile, the other 40 percent of your annual premium payment goes to corporate overhead expenses and of course the big insurance company’s bottom line profits.
Captive insurers have far fewer expense than big commercial insurance companies. In fact, estimates for the expense of captive insurance companies typically run as low as 15- to 30-percent.
This means that for every $1 million in premiums you pay for your business coverage to an outside insurance company, a captive insurer can save you anywhere from $100,000, up to $250,000 in annual insurance expenses!
A captive insurer (or “captive”) is a special-purpose insurance company formed primarily to underwrite the risks of the related company’s business, and/or the needs of other affiliated businesses.
It’s similar to a traditional, commercial insurance company in that:
The biggest difference between a captive insurer and a commercial insurance company is that a captive cannot sell insurance to the general public. Instead, it can only underwrite the risks of its related company or related affiliates —companies also controlled by you, the principal business owner. Regulations governing captive insurers are typically less burdensome than for traditional commercial carriers.
The most important benefits are: Your businesses can fully deduct the cost of premiums paid to your captive insurance company, and your captive can also invest the money received to provide for future claims.
The difference between premium income earned and claims paid is what’s known in the insurance industry as “float.” Warren Buffet simply described float this way:
“If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money — and, better yet, get paid for holding it.”
That’s the key to understanding the biggest benefit of a captive insurer. Not only do you get to essentially call you own shots in terms of adequately covering your business insurance needs, and get a tax deduction for the premiums paid, but you also get to keep all the money (that’s not paid out in claims) in house, within your overall business structure.
A captive insurance company takes time and expense to establish and operate, but it often provides significant benefits to you and your various business interests, including:
As you can see, a captive insurer can provide significant benefits. Keep in mind that, while these are complex structures that are highly regulated, when set up and managed correctly they are a perfect way for you and your business to potentially save millions of dollars in traditional insurance premiums and reinvest that money into additional profits for your business.
At TSP Family Office, we’ve successfully guided many clients through this process. And if you think your business can benefit from a captive insurer and want someone to help you simplify and streamline the process, please contact us at (772) 257-7888 for a complimentary consultation with one of our professionals.