Operating a business requires a constant, unwavering resolve to improve, tighten up, and mold a company into the well-oiled machine it was meant to be. Anticipating the “what ifs,” protecting assets, and covering losses are sure-fire ways to ensure that operations remain intact.
While insurance coverages in the conventional market provide some level of security, gaps in coverage could land even the most earnest business owner into hot water. This is where innovative thinking can give rise to a more robust risk management plan.
Exploring the possibility of covering losses through alternative risk planning doesn’t necessarily equate to going rogue, and leaning on untested, volatile tools. Rather, broadening the scope of business planning strategies, including those related to risk management, is likely to foster growth and decrease a business’s vulnerability to financial losses. Put plainly, alternative risk planning strategies such as the formation of a captive, can positively affect more than one aspect of a business.
So should business owners abandon their traditional means of covering their losses? The experts at Capstone advise entrepreneurs to keep their conventional insurance coverages, but supplement (and supercharge!) their insurance with a more extensive alternative risk program.
Worker’s compensation and certain other coverages are readily available and competitively priced in the traditional marketplace. But other risk coverages, such as windstorm, flood, and earthquake protection are often difficult insurance coverages to secure. The catastrophic potential is difficult for commercial insurers to manage, so minimum deductible levels and maximum limits are common. Captive insurance coverages can provide protection for these exposures with supplemental coverage provided by commercial insurers or government-sponsored programs. For example, businesses with a significant workers’ compensation exposure can save a portion of their premiums by including a deductible of $50,000 to $500,000 per claim, with an aggregate stop-loss. This deductible layer is a natural for a captive insurance company to underwrite on a reimbursement basis.
Alternative risk planning comes with the ability to create coverages based on need. Specialized coverages for risks specific to an industry, a location, or an individual business can be written through a captive insurance company. Businesses working in manufacturing, transportation, construction, in the medical field, and others need to be able to adapt to changing technologies and processes that may only affect their business or industry. For example, businesses that manufacture, import or export materials in foreign countries could face non-standard risks such as pollution-related losses and international political risks, including kidnap and ransom. The financial repercussions for business owners who do not have coverage for these types of risks could be enormous. In general, underinsurance for any mid-market business could equate to significant losses or even the closure of the business.
According to the Small Business Administration, as much as 60 percent of businesses never reopen their doors following a disaster. When devastation hits, they are literally cut off from resources needed to recover operations (Source: Property & Casualty 360).
There are many exposures that represent a form of business interruption and extra expenses that may not have been considered—a serious disruption to the supply chain is such a risk. Companies with major components of their manufacturing or distribution process that originate in foreign countries (with few substitutes available) are at risk if that supply cuts off – either from natural disasters, political unrest, or trade restrictions. In the event of a serious illness or injury to one of its employees, the company would incur a significant expense due to the urgent repatriation to the U.S. or to the nearest country capable of properly treating the illness. International insurance through a captive would cover repatriation to the U.S. or to the nearest country capable of properly treating the condition.
Similarly, the loss of services or of a key employee could have dire financial repercussions for a business that isn’t prepared. Many closely-held corporations are highly dependent on the services of key executives and if any one of these individuals left for an extended period of time, the company could face extensive costs finding a suitable replacement and miss out on key business opportunities.
Any claims that involve product liability, professional liability or an adverse regulatory action would cause some companies to incur expenses for a public relations campaign and activities meant to restore their customers' faith. Having supplemental coverage at the ready (by way of a captive) could help cover losses in excess of this amount.
Overall, alternative risk planning involves analyzing, assessing, controlling, avoiding, minimizing, or eliminating unacceptable risk for a business through unconventional means. By forming a captive insurance company, business owners have the opportunity to enhance their risk management program while amplifying their corporate business planning strategy.
How Can Alternative Risk Planning Affect Business?
Captives are insurance companies formed by a related party. Utilizing a captive as an alternative risk planning strategy affords benefits, in addition to enhanced risk management, such as asset protection, tax planning and estate planning. They are available to business owners who form captives under the Internal Revenue Code, principally Sections 831(b), 831(a) and 501(c)(15).
Investments of a captive insurer often include U.S. treasury investments, corporate bonds, and agency bonds. The affiliated operating company may also take out secured loans for business purposes when there is excess surplus. By law, captive insurance companies should first and foremost be established to cover the risks of its affiliated company, which can be domiciled onshore or offshore. These benefits are afforded only after businesses risks are assessed and insurance coverages have been determined.
Captive insurance has been gaining immense popularity, as mid-market businesses look to alternatives for covering risks and building value. Captives have been around for decades, but there’s never been a better time to supercharge your alternative risk planning strategy. It is a win-win for any business owner who is looking for better, more cost-effective ways to streamline business.