It is not uncommon to come across successful and profitable businesses that generate little meaningful wealth for their owners. For starters, businesses often face an array of expenses in addition to operating costs that sap revenue including administrative costs, leases and insurance. What profits remain are typically ravaged by taxes, weakening the business and hampering wealth accumulation by the owners.
Advanced Strategy Is Essential
For many successful businesses, there is a highly advanced strategy to form a second, profitable business that can facilitate significant wealth creation for its owners. The advanced strategy is to set-up and own its own insurance company, known as a captive insurance company.
What Is A Captive Insurance Company?
A captive is a unique insurance company. It includes its own corporation, insurance license, reserves, policies, policyholders, and claims. It is a sophisticated way to self-insure and is generally formed to insure the risks of its owners and related or affiliated third parties.
Captive Insurance Companies can:
- Replace Commercial Insurance
- Insure Enterprise Risks
- Insure Warranties
- Issue Performance Bonds
- Any Combination of 1 through 4 above
A captive insurance company can serve as the backbone of an Enterprise Risk Management strategy (ERM). ERM is a more sophisticated approach to risk management that holistically expands risk management. A company implementing ERM shifts from managing risk year-to-year to managing risk over multi-year horizon. This is possible because an ERM strategy with one or more captive insurance companies in place will usually accumulate loss reserves, providing increased risk management flexibility in the future. An ERM strategy also includes broader (or more) lines of insurance coverage. Typically, this larger insurance umbrella includes a blend of third party commercial insurance coverage and insurance coverage provided by the captive insurance company.
How Does This Advanced Strategy Protect & Grow Wealth?
First, the business is now able to insure risks that were previously uninsured. The added insurance protection provided by the captive plugs gaps in commercial coverage and addresses operational and existential threats that can threaten the very survival of the business.
Second, the business may save money on commercial insurance costs, particularly in areas where losses are low or predictable.
Third, the wealth of one or more companies with a captive insurance company is almost always higher than the wealth of companies without a captive insurance company. This occurs for two primary reasons. First, the parent company takes an expense as it pays its insurance premium to its captive. This lowers the parent company’s taxable income. And, the captive may make an 831(b) tax election if it qualifies as a “small” insurance company, so that its underwriting profits are taxed at a rate of 0%. A “small” insurance company is defined as an insurer that receives less than $2.2 million in premiums annually. Second, the captive earns a return on its reserve pool (or assets). And, the captive’s asset pool has been amassed with pre-tax dollars, enabling asset growth on a larger starting base.