7 Ways Businesses are Using Captive Insurance

Are Captives…Legit?

In a word, yes. Captive insurance companies are bona fide insurance companies formed to insure the risks of a specific “parent” or affiliated business. And just like with any other insurance company, premiums are paid to the captive to cover potential losses. It follows the traditional insurance model we’ve all come to accept. But why would any business need a captive? Why not put all your eggs in the Travelers, Liberty Mutual, or AIG insurance basket? The short answer is that commercial insurance coverages, underwritten by conventional carriers are likely to have gaps in coverage. Despite cute advertising campaigns featuring geckos and 50’s-era spokespeople, gaps have REAL, potentially devastating implications.

Imagine being a business owner of a highly-successful closely-held business; things are going great. Insurance coverage is intact. Then, something goes wrong—maybe your equipment breaks down, or maybe there’s been a major pollution event that elicits lawsuits from angry residents living around where your business operates. Now imagine the impending financial horror when you file an insurance claim, and it’s denied. An exclusion in the policy rendered your insurance coverage useless for the claim. Your bottom line is affected, business operations may stall, and the business could go belly-up.

THIS is why captives exist.

Captive insurance companies are used as a supplemental risk coverage measure, filling insurance gaps and giving business owners more control over their risk management.

Anyone can own the captive, and operating business owners are provided with substantial  planning benefits.  Under Section 831(b) of the Internal Revenue Code, premiums paid to the captive are tax-deductible (note: this tax benefit should never be the primary reason why a captive is formed. Tax and regulatory law warns against this practice). Additionally, asset protection, dividends, and secured loans from the captive back to the company may be available under certain conditions.

With the help of captive insurance planning companies like Capstone, middle market businesses are seeing what captives can do. We’ve compiled some examples of how businesses are using captive insurance. We’re taking a look at how manufacturing, construction, healthcare, transportation, and oil & gas businesses are leveraging broader, more tailored coverages written through their captive.

1) Coverage for Cyber Attacks

Most companies, including logistics and transportation companies, use a digital framework to house company data. Financial information, social security numbers, proprietary information and other sensitive data could be at risk for a cyber-attack. Coverage written through a captive covers a broad set of computer, network, and internet-related exposures including content liability, interruption of service liability, cyber-attacks, viruses, unauthorized access or use, and inadvertent errors or omissions. It can also cover the extra expense of a dependent business; coverage to extend to the differential between revenues generated before the loss and after the loss. Also on the list: cyber extortion, additional coverages for investigation and rewards, and loss system crisis management such as the costs for additional public relations and/or system consultants.

Captive Insurance Coverages

2) Equipment breakdown

Agriculture, construction, transportation, and manufacturing: businesses working in these industries may or may not outsource their equipment. Regardless of how they were acquired, equipment failure can mean a loss of revenue. Luckily, coverages written through a captive insurance company can address equipment breakdown, allowing for repairs or their complete replacement.

3) Legal Expense Reimbursement

Lawsuits and other legal issues may lead to captive insurer liability. Legal expenses can be reimbursed through a captive when there is no underlying insurance to provide defense, defense expenses have been exhausted, or the insured challenges the primary insurer’s failure to defend a claim to cover a judgement.

4) Pollution Liability

It’s common for media outlets to cover a major oil spill (from a large, publicly traded oil & gas conglomerate). The truth is that smaller, publicly-traded businesses contend with the risk of pollution liability. Construction, marine transportation networks, manufacturing plants, HVAC companies, and industrial pipeline contractors may have environmental exposures that aren’t covered under their existing insurance policy. This is true for many industries. For example, a major retail chain was ordered in March, 2011, to pay $22.5 million in a California hazardous waste suit for the improper handling and disposal of common products including pesticides, paints and pool chemicals (Source: Pollution: The Unrecognized Risk of Business Operations, Ace Group). There are a wide variety of exposures that may be commonly overlooked. An apartment complex for example, may have environmental risks stemming from underground heating oil tanks, lawn fertilizers or other chemicals stored on site. Pollution liability coverage written through a captive insurance company will cover losses resulting from a broad set of pollution-related exposures such as bodily injury, property damage, investigation costs, clean-up costs, fines, business interruption, and more.

5) Commercial Medical Malpractice Gap

Private practices, independent practitioners, and others in healthcare should opt for this type of coverage, as it expands medical malpractice coverage by covering risks that are excluded from or limited by the current underlying insurance policies.

6) Loss of a Major Customer

Oil & gas companies regularly outsource services to smaller contractors. In this industry, it’s a feast or famine culture; contract renewals are oftentimes dependent on the rise and fall of oil price and the “temperature” of the market. Loss of a major customer protects insureds against business interruption and the extra expense that would result from a loss of contract or any other temporary or permanent loss in a business relationship. Oil & gas is just one industry example, but virtually any business that is dependent on a few major customers can use this type of coverage to fund losses if those customers were to sever business ties.

7) Loss of Rents

Building management companies, independent property owners, etc. carry liability if something goes wrong on their property. Loss of rents coverage protects the insured against risks relating to their inability to collect rents for damaged properties rendered uninhabitable for any reason, including if damaged by fire, windstorm, hail, pollution, aircraft, automobile, flood, earthquake or any other fortuitous casualty event.

There’s been a lot of buzz around captive insurance lately—who should form a captive, why, what the implications are, what the IRS thinks, what the benefits are…

The buzz has given way to speculation, misinformation, and strong opinions on the social networks as to the legitimacy of captives as an effective risk management strategy. The truth is, business owners and their advisors are getting smart, realizing the benefits of captive ownership. The industry is reflecting their newfound sentiment, as captive formations are rising in the U.S., with new captive legislation being passed year after year. Moreover, captives are providing a level of risk protection that hasn’t been seen in the conventional markets.

To learn more about forming your own captive insurance company, please call Capstone at WEB_TEL or fill out the form on the top right.