CPA Practice Advisor - 9

FEATURE
Captives have the unique ability to
improve risk management and
simultaneously stockpile wealth.
coverage. Many policies are "cookie
cutter" and based on a generic risk
model that most businesses face
rather than one customized for
their business. Claims drive up the
future cost of insurance and there
are also marketing and distribution
costs as well as corporate overhead
and profit margins that are built in
to premiums.
Most importantly, the biggest
drawback to third-party insurance
is that premiums paid are a sunk
cost. Unless claims are made,
insurance payments are always
lost money (with the exception of
buying peace of mind). This lost
money - lost paying insurance premiums today - reduces a business'
flexibility in the future.

A BETTER WAY -
BLENDING THIRD PARTY
INSURANCE WITH
FORMAL SELF-INSURANCE
For many business owners, a far
more powerful approach to risk
management that overcomes the
trade-offs is to develop a layered
or blended approach. The key for
business owners to insure their way
to greater wealth is to own their
own insurance company, known
as a captive. A captive can form
the backbone of an Enterprise Risk
Management (ERM) plan, providing
formal self-insurance. By combining third-party insurance with
a captive insurance company, a
business owner can establish a far
more comprehensive and thorough
risk management approach. This

approach is also a better forwardlooking approach, because the
captive insurance company will
accumulate additional reserves
in years with low claims. These
reserves can provide more robust
insurance coverage in the future
and, when necessary, can be
accessed by the owner (or CFO) as a
war chest to address contingencies
or unanticipated risks.

WHAT IS A CAPTIVE
INSURANCE COMPANY?
Simply put, a captive insurance
company is a closely-held insurance
company that insures primarily
thought not exclusively your business. It is a C corporation and is
licensed and domiciled like any
large insurance company. Captives also have their own reserves,
policies, policyholders and claims.
Insurance policies are issued by
the captive to its parent or related
companies and are actuarially
priced. Owning a captive insurance
company is a sophisticated way to
self-insure, and captives are generally formed to insure the risks of a
business, group of businesses and
related or affiliated third parties.

HOW DOES CAPTIVE
OWNERSHIP ENABLE YOU
TO PROTECT AND BUILD
WEALTH
Simply put, a captive insurance
company is a powerful risk management and wealth accumulation tool.
By operating their own insurance
company, business owners and

CFOs can:
* Fill Third-Party Gaps: A captive
insurance company can issue
insurance policies that address gaps
not covered by third-party insurers.
* Utilize Customizable Coverage:
Captive insurance companies can
write customizable coverage for
the businesses they insure. Many
businesses face unique risks that
may not be addressed by commercial
insurers. The flexibility afforded by
a captive is extremely beneficial in
a complex world.
* Benefit From Few or No Policy
Exclusions: Captives can provide
broad coverage without the exclusions that riddle typical commercial
insurance policies. Insurance
coverage is worthless if an exclusion
prevents the insured from receiving
a claims payment when it needs it
most.
* Avoid Sunk Cost of Third-Party
Insurance: Premiums paid to a
captive insurance company remain
the property of the captive owners
and are retained as profit.
* Gain Access to a War Chest: Over
time, assets are accumulated in
a captive. Because the captive is
a formal form of self-insurance,
it benefits from insurance law
and favor able t a x t reat ment.
Hence, it is able to accelerate asset
accumulation.

HOW WEALTH IS ACCUMULATED
First, premiums paid to the captive
receive favorable tax treatment.
Premiums paid to the captive are
an expense to the parent company.
This lowers the parent company's
taxable income. As the captive
takes in premiums, it is taxed as
an insurance company on its underwriting profits (typically defined
as premiums less reserves to pay
future claims). For large insurance
companies, underwriting profit is
actuarially determined. However,
small insurance companies can

JUNE 2019 ■

make an 831(b) tax election, resulting in a tax rate of zero percent on
their underwriting profit. A small
insurance company is defined as
receiving premiums of $2.3 million
or less per year.
Second, the captive is able to
invest and grow a larger pool of
assets. Large commercial insurers have entire staffs whose sole
purpose is to invest reserves (that
have not been taxed).
For these reasons, a well-run
captive insurance company will
typically double retained earnings.
And, the same claims that would
be paid by the captive would have
to be covered out of retained earnings anyway if the captive weren't
in place.

ENJOY THE ABILITY TO
REAP LONG TERM PROFITS
When business owners are ready
to sell their business or retire, they
keep the war chest. A successful
captive amasses wealth for its
owners that can be accessed and
enjoyed in the future. Captives have
the unique ability to improve risk
management and simultaneously
stockpile wealth. ■
Randy Sadler started his career in risk
management as an officer in the U.S.
Army, where he was responsible for the
training and safety of hundreds of soldiers
and over 150 wheeled and tracked vehicles. He graduated from the U.S. Military
Academy at West Point with a Bachelor of
Science degree in International and Strategic History with a focus on U.S. - Chinese
Relations in the 20th century. He has been
a Principal with CIC Services, LLC for 7
years and consults directly with business
owners, CEOs and CFOs in the formation
of captive insurance programs for their
respective businesses. CIC Services, LLC
manages over 100 captives.

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