In our opinion, there is no better time to consider alternative risk transfer as a strategy to get more cost-efficient with respect to your current commercial property insurance, commercial liability insurance, workers compensation insurance, & commercial auto insurance.
As I write this the country and the world are about to exit the covid pandemic. If we frame the current conditions in terms of where we are in the property insurance, liability insurance & workers compensation insurance buying cycle; conditions couldn’t be more favorable to give your company a significant competitive advantage.
Taxes :
Since all 3 branches of government have changes hands in the last several years there are strong tailwinds pushing for significant tax increases which will erode corporate resources. We suggest utilizing a Captive Insurance strategy can give you significant tax efficiencies allowing you to keep the dollars inside your company to help reduce your variable cost structure. DOWNLOAD our Guide to Utilizing Captives by CLICKING HERE.
Coverage Availability & Rates :
Currently, we are in the through of a “HARD MARKET”; where conditions favor the insurance carriers as they restrict coverage and increase rates. Insurance buyers are frustrated because they have limited options. Further, they feel squeezed, and rightly so. The carriers are pointing to the “Social Inflation” of liability and commercial auto claims due to the insane jury awards. Buyers are pointing to “profits” earned and surplus growth to counter that claim. We think the buyers have a legit gripe.
Risk As Strategy :
Smart forwarding thinking CFO’s and C-Suite Executives understand that if they can leverage their balance sheets by increasing their retentions EFFICIENTLY, they can gain significant cost advantages that they can bake into their COGS (Cost of Goods & Services). If done properly they can reduce their insurance program costs by 35% which allows them to grow profits, market share, or both. Remember every dollar you save in your insurance program falls directly to the bottom line.
To understand if your company could benefit from a partial or full-on program restructuring CLICK HEREto schedule a 15-minute call. In 5 questions we can figure out if the strategy has legs for your org.
Have you ever wondered how utilizing captives, a high deductible insurance program, alternative risk transfer, self-insured retentions, or retrospective rating plans could further reduce your commercial insurance costs off your already low commercial insurance rates?
Too often business owners are chasing the wrong rabbit. They think that by purchasing their commercial insurance for less than they spent the year before is they accomplished their goal. We get it, it’s an easy benchmark to measure. If you succeed it’s a win; all be it a hollow win unless you really understand what you gave up to get that cheaper price.
Their real goal should be to lower their “Costs”, not the price of their insurance program. Nothing is more expensive to your balance sheet than cheap insurance.
The second huge mistake we see is that although their company has grown, sometimes significantly over the years, they are in essence the same insurance program they were when they were 20 employees; now they are 250, a thousand employees, and yet the commercial insurance is structured in the same way as when they first started.
This is a huge mistake because they are not leveraging their size and scale to reduce their insurance costs. I’m not talking about getting a lower rate because your sales are now at 100 million versus 10 million. That’s actually the illusion the commercial insurance market is selling. They are letting you feel like your reducing costs because of your scale; except they are holding back the best stuff only if you are smart enough to ask. We did a whole piece on the WHY they hold this information back in our “MISALIGNED GOALS” segment. Go there if you want to understand why.
For our purposes focus on the “HOW. First off we are assuming you have strong financials and a solid balance sheet. If you compare your balance sheet today with what it was 20 years ago, it’s probably night and day. Assuming you have solid free cash flow, credit lines, and cash reserves the question becomes, why are we buying so much insurance in the first place? To be clear I’m not talking about insurance limits. That stays the same due to your contractual obligations to your customers and lenders.
Leverage Your Balance Sheet To Reduce Costs At Scale
By leveraging your balance sheet you could restructure your present insurance program to incorporate some “risk-sharing” through higher retentions than by purchasing a “first-dollar plan. In a “first-dollar plan” the insurance carrier funds the loss from the “first dollar”. Any smart CFO worth their salt knows that any insurance coverage accessed for claims is essentially a credit line in reverse, except the interest rate on that credit line is crazy-expensive.
By increasing your retentions you score a lot of runs with one swing of the bat, pardon the baseball analogy. It’s called a grand slam. As your retentions increase the insurance marketplace looks at you entirely different than simply a purchaser of insurance products. You become a “Risk Partner” with them. This is important because the smart insurance carriers know that when you the end-user has “skin in the game” you generate significantly more underwriting profits than those that simply purchase first-dollar insurance plans. For this risk partner relationship, they give you significant discounts off the total premium for your risk sharing. A first dollar or low deductible insurance plan can never discount their rates low enough to get to the risk-sharing discounts.
Retaining Your Risk
Secondly, you purchase less coverage; the same limits, because you’re retaining some of the risks through deductibles or retentions. How you structure that retention matters. That’s another article. You can check out our quick piece on The Difference Between a High Deductible v.s. Self Insured Retention Since you are purchasing less your costs drop far more than just fighting for a lower rate. By taking higher retentions you can lower your costs by magnitude over just getting a lower rate.
Lastly, you can get access to a whole other section of the commercial insurance marketplace that caters to “Alternative Risk Financing” than you would otherwise have access to. You would never see a quote from this marketplace at the lower retention limits because that is not their appetite. They want larger, middle-market companies that want to be risk-sharing partners and not just insurance product providers.
Once you get a taste of what this looks like and how it can benefit you, then you will be tugging at our shirttails for a CAPTIVE STRATEGY.
So if you have been swimming at the same watering hole for years, with the same broker, and the same insurance carriers quoting you every 3 years we suggest you seek a whole new oasis. Call a Risk Advisor today, with 5 simple questions we can test whether this is an option for you.
How much does it cost to start and run a captive insurance company? It’s the most frequent upfront question we get from organizations that are looking at starting their own captive insurance company for their organization. The short answer is zero, but when we tell business this they’re left in shock. After we walk them through the process of how we got zero as the price, it makes perfect sense.
Let’s start at the end and work back; reverse engineer this. First off it’s an investment that yields an ROI, not an expense like your current insurance program. A well-run captive generates has gross savings of at least 30% off your current insurance program on average; irrespective of what structure you’re coming from; unless of course, it’s another captive. That’s because the captive shares in the underwriting profits would typically go 100% to your insurance carrier. Curious about Captives? If you want a better understanding of what a Captive is, and how it could fit in your organization CLICK HERE to download our free ebook.
Further, the risk-sharing mechanism is designed to reduced your upfront premium outlay. Your betting on yourself that your losses will be less than your premium & admin costs. In a well-designed, well-run Captive the results are undeniable. You can only generate & retain these profits, with tax efficiency, in a captive structure. Thus if you back out the cost to run and administer the captive from the profits you generate the cost is ZERO! Someone smart told me years ago that you have to spend money to make money.
In order to consider a captive structure you need these three (3) attributes :
Size & Scale: You need to be spending in excess of $500k in your property & casualty insurance program. You can include employee benefits here too if you wish. Many captives are set up to fund employee health expenses to save on their health & benefits insurance premium. The closer you get to $1 mill in total insurance spend, the better this solution looks. As the numbers you expense in your insurance program increase there is a direct correlation by % to your end benefit.
Free Cash Flow: In finance terms, you need to have strong financials and good free cash flow. The captive will plug into this “resource” and amp it exponentially for your company by keeping that free cash flow tax free instead of it having the direct profits spill down into the partners’ individual tax return.
Underwriting Profits: Too often when we interview companies and CFO’s about a Captive Alternative their main driver is looking for a cheaper insurance quote. They think that by forming a captive they can out run their claims problems and high insurance premiums. This is a fools’ errand. The last thing you want to do is switch places with the insurance carriers if THEY aren’t making money on your account.
Our demarcation line is a minimum of 35% undeveloped loss pic; which is a ratio between incurred claims & premiums paid. If your loss pic is just over that 35% threshold we should have a discussion. If your over 50%, you need to solve your claims problems first before you can consider a captive solution as a potential option.
Breaking Down the Cost of a Captive
You can’t simply compare the “cost” of a captive to the “cost of your current insurance program”, especially in a 1-year snapshot. The correct way to evaluate whether a captive solution is right for your organization purely from a numbers standpoint is a (5) year window. The data set is larger and more representative of your management team. It’s less “noisy” from a numbers standpoint, enabling you to see the big picture.
Further to simply look at this purely in terms of financial implications we suggest is short-sighted as well. This a long-term strategic play. Captives have major strategic advantages as you compete for business on the street than simply buying and expensing insurance year over year.
In our view, Captives are an investment that yields a consistent, measurable ROI, not a cost or expense. It’s an investment in YOU, for YOU! If you want to be at the vanguard and stay 3 steps ahead of your competition we suggest you open up a dialogue of what this solution could look like for you. CLICK HERE to have a 10-minute discussion with one of our Risk Advisors.
Let’s start from square one. Captives, unlike insurance companies, are risk financing structures that do not pool risk between thousands of companies in exchange for a premium. They are expressly built to act just like and replace insurance companies by efficiently managing claims and paying losses from a special captive account themselves.
The reason very large companies like Monsanto and Coca Cola utilize captives is because they have risk management departments that manage their losses and risk so well. Rather than pay premiums to an insurance company boosting the carriers profits they ARE the insurance company which means they pay premiums to themselves substantially lowering their risk financing (insurance costs) with the potential of earning profits on those same lower premiums.
Remember when you purchase insurance from a company like AIG you are essentially financing future losses from general liability or workers compensation claims due to employee injuries or future litigation. If your losses are low the insurance carrier, AIG, generates a profit. Coke and Monsanto essentially say they have such a high degree of confidence in their ability to mitigate and manage their future losses and claims that they want to keep that profit for themselves. Further they believe financing those futures losses themselves rather than have an insurance carrier finance those losses by charging for that service is a more efficient way of utilizing their cash reserves.
Micro Captives 5 key features & objectives:
Substantially lowers your cost of Risk Financing (buying insurance)
Having skin in the game should boost your results in terms of reducing losses.
Gives you far more control than the present system which benefits the carriers and the brokers first as goals are misaligned.
Should produce an ROI on your cash reserves which is how insurance carriers make money.
Lowers your overall unit cost structure generating higher profits and/or greater market share due to better competitive position.
A fraction of the cost to start and impliment compared to a standard captive arrangement.
Typically, captives are set up to replace commercial insurance carriers for one or multiple businesses with the initial goal to lower the companies’ risk based costs, eventually having the captive become a profit center. This is accomplished through all the above stated bullet points.
Micro-Captives are smaller captives designed for mid-sized companies under $ 1 billion in sales. The reason you usually only see large companies set up Captive Insurance companies is because it takes a lot of capital to fund it. Essentially, you need a lot of money to build up a large cash reserve to pay or fund future losses. Further, you need to set up infrastructure including a claims management intake team, legal representation, adjusters, actuaries, accountants, etc. These departments and functions come with the insurance carriers as one bundled product when you purchase insurance from a carrier such as AIG. When you set up a captive you need to build this infrastructure out for your own captive which can be a significant investment. This is why you don’t see many small businesses utilizing captives; UNTIL NOW!
Recently there seems to be huge interest and growth in Micro-Captives to efficiently fund certain tranches of risk, particularly high deductible programs. Section 831(b) of the U.S. Tax code stipulates different income tax rules for smaller insurance companies or captives.
The Captive must meet the following qualifications:
The captive must qualify as an insurance company for tax purposes. Translated this means it must transfer risk in exchange for capital.
It must be operated & regulated like an insurance company with sufficient capital reserves.
The Captive must be a U.S. Taxpayer, either domiciled in the U.S. or domiciled off shore but having elected and qualified under tax code section 953(d) to be taxed as a U.S. insurer.
The Captive’s gross premium income for the tax year in question must be less than $1.2 million. This premium threshold applies to all insurers in a single consolidated tax filing in 2016.
Congress recently passed the Protecting Americans from Tax Hike (PATH) which increased the tax-free limit to $2.2 million in premium income beginning in tax year 2017.
WHAT’S THE BENEFIT Of A MICRO CAPTIVE ?
There are a few legitimately big ones. The first is that it allows small companies to really build a war chest. If you’re an S-Corp, or LLC any excess cash gets passed through to the owners’ personal tax return. This means contingent on your tax bracket, earnings and AMT you can lose almost 40% of those funds to taxes. Over several years that amounts to a lot of capital that could have been put to other uses where you could actually get an ROI.
In tax year 2017, if a business using a 831 (b) captive writes less than $2.2 million in premiums then the business is only taxed on investment income and NOT it’s underwriting income which could be substantial if your losses are low. This means that if the business paid $1 million in annual premiums this amount becomes a tax-deductible expense for the business while remaining an asset on the books of the company owned Micro Captive.
The purpose of this piece is not to provide the reader all the available information and calculations as it relates to Micro Captives. Quite simply, this is an intro piece meant to get folks who are buying first dollar or smaller deductible programs to begin to see a smarter more cost efficient program built specifically for small to mid-sized companies.
One of the reasons you don’t see these solutions being offered by your insurance broker or insurance carriers is because the net effect is it lowers the premiums you pay which do not benefit either of them as they are compensated on higher premium volumes.
If you would like to have deeper level discussion on how this solution may fit into your current insurance program, a Risk Advisor is waiting to field your call. Call (914) 357-8444 or simply CLICK HERE to schedule a call.
