In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Jarid Beck, the Director and Co-Founder of Risk Management Advisors, Inc., a firm specializing in creating and managing captive insurance firms for businesses. Beck is a recognized expert in the design, implementation, and management of alternative risk management strategies. He has a diverse insurance background, allowing him to deliver insurance solutions to clients in a wide variety of industries.
In this episode, you will learn:
- What is captive insurance?
- Reasons for implementing captive insurance.
- The process of implementing captive insurance.
- Captive insurance costs.
- The experience of captive insurance for the insured.
- And more!
Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.
Welcome back to the Agent of Wealth Podcast, this is your host Marc Bautis. On today’s show, I brought on a special guest, Jarid Beck. Jarid is the director and co-founder of Risk Management Advisors. He’s a career specialist in the design, implementation and management of alternative risk management strategies, including self-insured plans and captive insurance companies. Jarid, welcome to the show.
Marc, thanks for having me.
My pleasure. When I talk to business owners, there are a few things that they’re always looking to improve. One is more revenue. They also want to be more tax efficient. And a lot of them also look at their overhead. One of the biggest overhead expenses is insurance. I hear gripes about premiums and premiums constantly rising. Plus, I think a lot of business owners don’t have a clear understanding of what is and what isn’t covered by their insurance – meaning they may not actually have enough coverage. Jarid, can you start off by providing a basic overview of what captive insurance is?
What is Captive Insurance?
Yeah. When we, at Risk Management Advisors, Inc., got into the space and started working with more business owners, we found that they knew how to get a rate of return from their business; they knew how to grow companies; but they were being attacked by the things that stripped their wealth away. That’s taxes and overhead in the form of insurance costs.
When we did research, we discovered captive insurance companies. At a basic level, captives are an insurance company that a business sets up to insure their own risks.
And a lot of people at this point, say, “You mean like self insurance?” Yes, it is self-insurance – to some extent – but it’s a formalized version of self-insurance, where you actually form a separate corporation and get it licensed by the Department of Insurance to issue the policies that your business needs.
So captive insurance is really a full on insurance company, created for this purpose?
Correct. To create a captive insurance company, you go to a jurisdiction that has captive enabling laws, which are laws on their books that allow you to set these companies up, and it’s fully regulated.
Now, captive insurance is different from the insurance companies that we see on TV, like Berkshire Hathaway, AIG and Pacific Life. A separate department regulates those traditional insurance companies, and captives have a different set of regulators. The regulators that oversee the captive section are more lenient and user-friendly. But, again, it is still a regulated business.
Can you set up a captive insurance company for all types of insurance? A business might have medical insurance, workers’ compensation, general liability insurance, cyber security, and so on. Can a captive insurance company blanket all of those different areas?
Yes. There are different rules and thresholds around which type of coverage would be feasible for somebody to put into captive insurance, but at base level, it’s possible with most types of business insurance. Where captive laws generally don’t apply is with personal lines of insurance, like homeowners insurance and things of that nature.
But as it relates to business, coverages that can be addressed through a captive include business insurance, workers’ compensation, errors and omissions, professional liability, general liability, property insurance, cyber liability, directors and officers’ coverage, and medical insurance.
Reasons for Implementing Captive Insurance
So does captive insurance usually result in lower premiums? Or does the benefit come from having more control over the insurance? Is it a combination of the two? What are the main reasons you see businesses implementing captive insurance?
It’s a combination, and it depends on the line of coverage and the motivating factor(s).
A common misconception is that captive insurance immediately results in lower premium cost. Quite often, we’ll get a call from a panicking or desperate property and casualty broker… “Hey, my client is interested in looking at captives. We’ve got a tough renewal on this policy coming up.” But usually they’re not actually interested in captive insurance. What they’re really interested in is a better quote, or a lower quote for that particular policy.
What captives do is give you the ability, over the long term, to avoid the roller coaster ride of the insurance market. Long term, you fund the insurance company – the captive – and when premiums go up or premiums go down, it doesn’t matter. Your premiums are kept stable. That’s really one of the main benefits.
Other driving factors for implementing captive insurance is the lack of available coverage. The insurance market lags behind so many risks and exposures that businesses face nowadays. So oftentimes, companies can’t get coverage for things that they need.
We have clients with well-funded, well-established captive insurance companies that can step in and provide the business units coverage for those risks.
The Process of Implementing Captive Insurance
Can we walk through an example? Let’s say you’re talking to a company interested in implementing captive insurance. They hand you a pile of their insurance policies… what’s the next step after that?
The first step is collecting copies of a business’ policies, including having a discussion with their broker or consultant to see what’s currently being covered, and what’s not. Then, from that list of things that are not currently covered, we assess which areas pose a risk to the business. Then we can build a captive program that addresses those.
I’ll give you some primary examples… Let’s start with property insurance. Some of the basic exclusions in property insurance are asbestos and mold – both are standard exclusions inside of most property policies. Saptives can be utilized to address those exclusions.
On the West Coast, where I live, most property insurance policies have large deductibles for earthquakes. Sometimes earthquakes are excluded altogether. So if a business has a property policy in California, that’s great, but they’re still facing the risk that all California real estate holders are: an earthquake. Our company has set up a lot of captives to address the earthquake exposure.
On the East Coast, there’s a higher risk of water damage from a hurricane or wind-driven rain. There are big deductibles – or big exclusions – on property policies out east for this, so we have a lot of clients that utilize captives to address those gaps or deductibles in coverage.
Another good example is, here in California, if you think about employment practices liability – sexual harassment, wage and hour issues, etc. – individual employees can have a disagreement with an employer over how they were treated, and seek restitution for the mistreatment. Traditionally, nationwide, that’s on a one to one, individual to company basis. In California, there’s a set of laws that allows that employee, if partnered up with a plaintiff’s attorney, to find one other person who is potentially aggrieved, and turn it into a class action lawsuit, under the pretense that if this business did it to two employees, then they must have done it to every employee of that company over the years. This balloons the issue into a much larger claim.
It’s been going on for a number of years here, and thepolicies in the traditional insurance market don’t offer coverage for it. Firstly, the carriers don’t price policies to cover that, and if they did, it would be very expensive. Secondly, they’re just not really interested in dipping their toes into those waters. That’s another good example of something captives can address.
Okay. Back to the business owner, if they have a coverage – say, $1 million for cyber security – that they want to retain, what amount of money would they have to fund into the captive to keep that coverage?
So there’s two different paths to take. We’ve been discussing risks you can’t get coverage for with traditional insurance. In those cases, we set up a policy and fund premiums into the captive to cover what’s traditionally excluded and causing risks in the business.
The second path is looking at the coverages you are paying for. Let’s say workers’ compensation, for example. If you are paying a million dollars premium, what we would do is go to underwriters, carriers and the reinsurance markets to figure out how much risk the captive insurance will have to take for that business owner to get a reasonable savings on their premium.
In the example you gave, a company might be paying a million dollars in premium, but if they have the captive take the first $250,000 of any claim that would come down the road, maybe there’s an insurance company that would write anything up and above that for $400,000, or a half million.
So we’re going out and doing that exercise. In this case, we might have the captive take on a certain amount of risk, and then have a reinsurance company, or excess company, step in up and above that to protect the owner from anything catastrophic.
Captive Insurance Costs
Okay, makes sense. When someone sets up a captive for the first time, is it a big outlay of money that they have to put in, or are they leveraging and borrowing the money that goes into it? How do they initially fund it?
Good question. There are two components to setting up the captive. One is the fees associated with the set up. Fees will vary based on the type of structure, but one-time set up is typically anywhere between $30,000-$50,000. And it’ll cost roughly that, per year, to keep it running. But that will depend on the type of structure.
When the captive insurance company is set up, there’s also a capital contribution. If you think about any business, there’s costs to turn the lights on, get the licenses, and so on. Captives are no different. Again, the costs depend on the type of structure, but typically that’s a one-time contribution.
Then the premiums get paid into the fund from there on out.
Those premiums, are they what the company is used to paying? Whether they’re a little bit higher, lower or the same, there’s not an enormous capital infusion to cover some of these risks that the captive is taking on, is there?
That’s a part of the analysis. We call it a feasibility study, where we sit down with the policies, budget considerations and objectives of the business, looking at it holistically. We determine what is feasible, what the capital outlay would be and what the premiums would be. Then the business owner can make a decision to go through with it, or not.
Part of it is based on budget, capital allocation, short and long term objectives. But the items that move forward are within a client’s budget.
The Fastest-Growing Type of Captive Insurance
Medical insurance is the fastest-growing type of captive that we have right now. It’s been that way for at least 5 to 10 years. The reason for that is the costs go up every year, and there’s fewer and fewer carriers. In some markets, there’s as few as three or four to get quotes from.
While the costs go up each and every year, they tell you less and less about why the costs are increasing. And then it’s doubly insulting, because most of these companies are publicly traded, so you can see that they have record earnings. It seems they’re jacking up employers’ premiums while simultaneously making money for their shareholders.
Over the years, some business owners have reached a breaking point. For employers with a significant number of employees, after the payroll line item, medical insurance is typically second in line. Medical insurance is a big expense, so a lot of business owners ask us, “How can I get some relief?”
Saving money sounds good, but what if somebody gets cancer, and the business has a bunch of large claims?
Fortunately, on the medical side, there’s a very robust reinsurance market, or stop loss market, where a number of insurance companies will come in and take risk, up and above a certain amount, to cap what the company or the captive would be responsible for.
That combination of factors has led to a big growth in the captive space.
Is that just with medical, or is that across all different types of insurance?
Got it. Is there a certain size company – whether employees or revenue – that moving over to a captive makes more sense?
Yes. There’s different metrics. If you’re looking at group medical, it’s typically 100 employees and a million dollars in annual premium. But you can still do some stuff smaller than that. For workers’ compensation and some of the property and casualty lines, a million in total premium is the cutoff.
That being said, there are some nice programs out there that can provide good savings, down in the $300,000-$400,000 range. These didn’t exist as few as two-three years ago, but there are some really nice solutions now. That’s been exciting.
If you’re looking at exclusions, or just gaps in coverage, we would typically be working with businesses that have $15 million in revenue and above. Because, like we talked about, there are some costs associated with set up.
Thinking about this from a business owner’s perspective, what’s needed to operate a captive?
The idea behind our company is we work as the captive manager. The job of the captive manager is to essentially quarterback and run the day-to-day operations of the captive, so that the business owner gets all the benefits, but that it doesn’t distract from the day-to-day operations. I always tell people, “You can invest as much time as you want into it, or stand back at an advisory level and let the manager run it.” Ultimately, it doesn’t have to be distracting, or take too much time.
I know you mentioned that sometimes captive insurance doesn’t result in lower premiums. But does it ever? Is that one of the reasons why people will implement captive insurance?
It can be one of the reasons. If the premiums are lower in the first year, that’s fantastic. But the idea is that, over time, as the captive builds up profitability, it builds up surplus.
Instead of premiums going up, it’s more likely that premiums are held stable or lowered over time. It’s more sustainable, because as you build up a strong insurance company in the long run, you can sustainably charge lower premiums back to the business.
When we were talking about medical insurance, you were talking about if someone gets diagnosed with cancer, which could be a big expense for the business. You said there’s the opportunity to go out to the reinsurance market to get stop loss coverage. Do you see that across other areas of insurance?
Just like there is with medical, there are excess policies or reinsurance programs for other types of coverage that the captive can participate in to protect against catastrophic loss.
For example, workers’ compensation. It might be common for a company to take the first $250,000 of any claim that would come down the road, but then they’re going to have a policy up and above that to protect themselves from permanent disability, where the carrier’s paying out for years and years.
Again, you would have that excess or reinsurance up and above that. And where that reinsurance or excess would step in is going to be dependent on size factors and availability, but that’s a big part of the equation.
The same thing goes with professional liability coverages. The captive insurance will only take as much risk as makes sense, but then ultimately lay off that catastrophic coverage to another carrier.
There’s also risk distribution. So you think about auto insurance as, if I get in an accident, State Farm doesn’t go bust because you drove safe that day. And so they have some accidents, some not. Captives can also participate in pools where they’re sharing a portion of the risk they’ve retained. So having an extra layer, extra element of reinsurance, even for the risk, they do retain inside the captive.
There are mechanisms and methods for laying off the risk.
In that example you were giving about workers’ compensation, you said the company will cover the first $250,000 and then have some kind of policy above that. Does that mean that the captive insurance company has $250,000 sitting, in the event that a workers’ comp claim comes? Or what is the cash correlation to what the coverage is?
It’s determined in a couple different ways. One is, the captive will have its own actuaries and underwriters that it brings in to rate up each policy. In that case, that $250,000 will be calculated based on the employer’s actual experience. It might be $250,000. It might be less. It might be more. But it’s based on their rates and their losses.
The other item that’s helpful is going top down. Let’s say the original premium was $1 million, and then we move the client’s retention from zero to 250. Now the carrier comes down and says, “We’re only going to charge you $400,000 in premium, because we’re stepping in at the 250 level as opposed to the first dollar.” Well, that’s pretty instructive that the risk, $250,000 per claim, has appropriate funding in the $600,000 range. That can act as a benchmark for building out the premium.
So you can look at it top down or bottom up, but it’s calculated individually per risk.
What is the difference between self-insured captives? Is there a distinction between the two of them, or are they similar in terms of how they’re structured?
So we discussed the regulatory and the formal corporate governance difference between just self-insurance funds and setting up a captive, but there are some real financial benefits to using an insurance company.
If I self-fund, and I say, “Hey, I’m going to set money aside for a rainy day, for XYZ risk,” I don’t get a deduction for that. I don’t get to expense that unless I actually have a loss. So I set this money aside, out of my profits, but I’m still paying taxes on it. Even though I might have a loss down the road, I’m still paying taxes today.
What the captive allows you to do, when properly structured, is pay that premium over to the captive. Then you expense the premium, just like you would with all of your other lines of insurance coverage. So you get to accelerate that tax deduction for the premiums paid to the captive.
Then, on the insurance companies’ side, insurance companies get favorable tax treatment under the Internal Revenue Code, 831(a). They get to take premium dollars and put them into reserves to pay potential claims. That reduces, or potentially eliminates, the captive’s tax liability. So it becomes a very tax efficient way to reserve for potential losses to a business.
Frankly, Congress put that code into effect to give businesses the ability to create reserves for things they couldn’t get coverage for, or couldn’t get effective pricing for.
The Experience of Captive Insurance for the Insured
How is the experience of captive insurance for the insured? Take medical insurance, for example. Is the experience for the insured employee any different then it is on the traditional market?
It certainly can be. One of the byproducts of recouping the carrier’s underwriting profit on medical insurance is, at renewal, instead of raising copays, deductibles and employee contributions, you can actually lower them, creating richer benefits.
In fact, when we consult with business owners, we recommend they do exactly that. It sort of acts as a social contract, if you will: The business reaps benefits and underwriting profits, so they can reinvest in the employees via lower contributions and better benefits. That naturally facilitates a better experience.
And a byproduct of having captive insurance on medical is you have access to all of the data, so the business owner can determine what services they should put in place to enhance not only the financial outcome, but also the experience that the employees have. So it can definitely be a component to exiting the traditional market.
Yeah, that makes sense. Well, we’re just about out of time. Jarid, I want to thank you for being on The Agent of Wealth Podcast. You gave some great information on how a captive insurance program can help a business owner. How best can someone find out more information about what your company does?
You can go to our website, riskmgmtadvisors.com. There, you’ll find all of my contact information, plus some great information on the items we discussed today.
Perfect. We’ll link to that in the show notes. Thanks again, Jarid. And thank you to everyone who tuned into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.