One of the most attractive advantages of a captive insurance company over traditional insurance is that the captive can underwrite almost any type of risk the captive owner desires. The important qualification is that it must be commercially reasonable—but it doesn’t have to be commercially available. In fact, this very advantage drives many to establish a captive. A business may have a specific risk that is either unique to the market or not common enough for the market to have enough experience with the risk to be comfortable underwriting it. In this common occurrence, self-insurance is the only option a business has unless that business operates a captive.
Archive for September, 2016
I am continually surprised at how many organizations are led to believe they can use a captive in ways that range from being wrong for their business to being simply illegal. For example, I spend much of my time speaking to attorney-, accountant-, and insurance-professional associations. As a result of my 30-40 presentations per year, we are blessed to be seen as a resource for these groups. I recently got a call from an attorney in California whose client just signed an engagement letter to form a captive with a national promoter. The captive was an offshore captive and the policy the client’s captive would write is terrorism insurance. I told their attorneys I needed more facts. Once they started describing that the client manufactured high-end, handcrafted musical instruments in a remote town of California with a population of less than 10,000, it did not make sense. With annual profit of $2,000,000, it was ridiculous to think the IRS would designate $1,200,000 in terrorism insurance premium an “ordinary necessary business expense.” In this case, the IRS would not even have to challenge the legitimacy of the captive insurance company; they could simply outright deny the deduction for the insurance.
There are many reasons an organization chooses to form a captive. The best way to fully understand the specific opportunities and benefits for your particular organization is to consult with a risk management advisor who has expertise in the captive, traditional, and the alternative risk transfer insurance markets. Such a professional would likely gather some initial information, evaluate the organization’s risk-management goals and then, if it appears a captive insurance strategy is at least a realistic possibility, recommend conducting a formal feasibility study. This process is an essential component of determining the projected return on the investment made to establish and manage a captive. After all, forming a captive is a risk-financing strategy. If the benefits are strong enough to meet or exceed the organization’s internal ROI requirements, then captive formation warrants serious consideration. Although the package of benefits behind each captive will be unique to the particular organization it serves, there are certain benefits that are relatively universal.