We all know that insurance is a necessary expense for any business, and we know that the expense goes up in direct relation to increased claims or a higher risk profile. But what is difficult to reconcile is when your premiums increase exponentially because of claims made by other businesses in your industry.
Captive insurance can be a game-changer for this problem, offering customized premiums, improved cash flow, tax advantages, and more.
At ReNu Insurance Group, we've helped over 130 businesses become profitable as captive owners. We helped them create more robust safety and risk management programs to minimize claims. Because of this, they've seen the financial pros of captive ownership and have directly benefitted from bettering their business.
In this article, you'll learn about how captives can financially benefit your business, especially if you're focused on risk management and minimizing claims. That way you can determine if captive insurers are a good fit for you.
What financial advantages come with captive insurance?
Some of the financial advantages of captive insurance ownership include:
- Customized premiums for your business;
- Improved cash flow;
- Investment opportunities; and
- Cost control.
Customized premiums for your business
With captive insurance, businesses can customize their premiums based on their risk profiles and loss histories. This means more accurate pricing and potential cost savings compared to traditional insurance. For example, a construction company that has very few claims and manages its risk well will still see rising renewal premiums if the construction industry as a whole sees an increase in claims.
Once a company enters a captive, however, their individual loss experience stands alone rather than reflecting industry trends. This means a captive owner with well-managed risk and few claims will see lower premiums in the captive than with traditional insurance.
Improved Cash Flow
Captive insurance allows businesses to retain the underwriting profits and investment income generated by the captive. Because of this, a captive owner can see an improvement in their cash flow.
Typically, businesses with good loss experience see a 28% reduction in renewal premiums in the first three years. In addition, the captive will have about 25% in underwriting profit, assuming no change in claims experience. When added together, most businesses can see almost a 50% reduction in the total cost of risk.
Investment Opportunities
A captive insurance owner/member can invest the money otherwise allocated to premiums within the captive. This opens potential investment income and growth for the captive’s assets, providing additional financial benefits.
Cost Control
By assuming risks directly through the captive, businesses have more control over their insurance costs. This means that with proper risk management and loss control measures, the captive owner or member can potentially reduce the frequency and severity of claims, leading to long-term savings.
You might be wondering how your business would do when part of a captive. Take your captive assessment to see your results and how you would perform.
Does captive insurance ownership provide any tax benefits?
The tax advantages associated with captive insurance ownership can include:
- premium deductibility;
- tax deferral; and
- estate planning benefits.
This all said you don't want to be a captive owner only for the tax benefits advantages, which will also be explained.
Premium Deductibility
In most instances, premiums paid to a captive insurance company are tax-deductible as a legitimate business expense. This can lower overall tax liability for businesses.
Tax Deferral
Some captive insurance allows for the deferral of taxes on underwriting profits and investment income until they are distributed. This gives businesses increased cash flow and the opportunity to reinvest the funds for further growth.
Estate Planning Benefits
Captives can serve as effective tools for estate planning. By transferring assets into a captive, a business owner may be able to achieve estate tax savings and facilitate the succession of their business to the next generation. However, this shouldn’t be the overriding factor in considering a captive.
Don't be a captive owner solely for tax benefits
If you're considering captive insurers solely for tax reasons, being a captive owner might not be for you. Red flags are raised for the IRS when a business owner enters a captive only for tax benefits.
The IRS has been cracking down on micro-captives within the last decade because they have been suspected of tax avoidance.
The point is you shouldn't join a captive only for tax benefits. And a captive should be formed for non-tax purposes, especially when they need to meet specific criteria so the IRS isn't down their throat.
Watch this video to understand the relationship between the IRS and captive insurers:
How does a captive insurance program make my business more profitable?
With traditional insurance, 60% of every premium dollar the policyholder pays is set aside for any loss the insurance carrier incurs. At the end of the policy period, whatever is left over becomes profit for the insurance company. With a captive, that profit goes directly back to the captive owner.
Captive insurance ownership can also make a business more profitable by providing:
- A laser focus on risk management;
- Incentives for loss control;
- Investment income;
- Enhanced coverage and flexibility; and
- Potential dividend payments;
Focus on Risk Management
Captive insurance programs encourage businesses to take a proactive approach to risk management, focusing directly on the risks that matter to them. By assuming and managing risk directly, businesses can implement strong risk mitigation strategies, reducing losses and improving profitability.
Incentives for Loss Control
Captives provide financial incentives for businesses to invest in loss control and risk reduction measures. By implementing effective risk management practices, businesses can minimize losses, leading to better profitability.
But what are the financial disadvantages of captive insurance?
Captive insurance ownership can provide businesses with several financial advantages. These include such benefits as customized premiums, improved cash flow, investment opportunities, cost control, tax advantages, a heightened focus on risk management, incentives for loss control, investment income, enhanced coverage and flexibility, and potential dividend payments.
But, of course, that’s not the entire picture. Along with the unique financial advantages of captive insurance ownership, there are several potential disadvantages that any business owner needs to know before determining whether a captive is a good fit and how it might impact their bottom line.
Read more about this important aspect of captive insurance ownership in:
If you want to know how much you would need to invest to get into a captive and see how much underwriting profit you can make, take our insurance calculator to see your results.
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