Why would anyone form a captive?

Raise your hand — and be honest — if, during your formative years, you wanted to be an insurance company executive.  Did you raise your hand? You’re lying — through your teeth — because that would have been the absolute last thing on your list (Me? I wanted to be just like my guitar hero Rory Gallagher, but that’s a long story). And yet, that’s exactly what it means when a business owner says he wants to form a captive insurance company– it’s a public admission that your company wants to form an insurance subsidiary.

Why in the name of God would you want to go into the insurance business?  There’s actually a number of really good reasons, starting with this: people who form captives have moved from the “perfunctory purchase” phase of insurance to the “knowledgeable purchaser” phase.  What, pray tell, is the “perfunctory purchase?” First, it’s a great example of alliteration. Second, it describes how most businesses look at that their insurance purchase. No one wants to buy insurance, but they know it’s the smart thing to do.  So, they call an agent – any agent will do (breathing and heartbeat are entirely optional) – describe their business, ask for a recommendation, buy the coverage, get the policy, and then place said policy into the lower right-hand drawer of their desk, where it resides under a bottle of scotch until renewal.  It’s a “grudge purchase;” much like eating your vegetables when you’re a kid. It’s the “right” thing to do, so you do it. But you really don’t want to.

Far fewer people are a “knowledgeable purchaser.”  What leads to the change? It’s usually one of the following:  

  1. A really bad experience with an insurance company.  Here’s my favorite, all-time example (cue Jack Webb toned voice saying, “The names have been changed to protect the innocent): a named hurricane forced company X’s business to close for a week.  Company X looked at their insurance policy (which was in the lower right-hand drawer of the owner’s desk under a bottle of scotch) and realized they had a loss of income rider. “We’re saved,” they thought to themselves.  They read the policy (which was the first time they actually did so), learned how to file a claim (the policy included somewhat easy to follow instructions), and did just that. Then the insurance company said, “No.” Well, actually, what they really said was this: “See this clause in the contract?  It says that our payout is capped (coincidentally at a much smaller amount) if a utility outage caused the loss of income. That’s our story and we’re sticking to it.” This led the company to realize that they weren’t very happy with their policy, leading them down the “captive” path.
  2. They’ve grown to size “X” and realize they now have something to protect.  Entrepreneurs are “nose to the grindstone” types, always looking for the next client, contract, or sale.  During the early period of their business, they are all about growth. Then they get to size “X” and realize they have something to protect.  At that point, they open up the lower right-hand drawer of their desk, pull out the bottle of scotch, pour themselves a drink, and actually read their insurance policy to see what it covers (at which point they realize it was written by lawyers, so they call someone to translate the legalese into English).

Both situations have something in common: the business owner has an insurance related problem (and the only remedy is more cowbell!  Wait, wrong article). In the first situation, they thought they had coverage only to discover they didn’t have nearly the amount of coverage they thought they had.  In the second, the business owner has become far more aware of loss and wants to do something about it. Both situations force the business owner to acknowledge the possibility of loss.  And – cue drumroll because this is the payoff section of the story – they now want to do something about their risk by taking control of it.  Remember the old adage that the first step in dealing with a problem is admitting you have one?  That’s where the business owner is now. He’s ready to learn more about controlling his risk, which makes him far more open to the idea of a captive insurance company.

And that is where you, intrepid reader and insurance producer, step in.  You tell your client that he can form his own insurance company, which allows him to take more control of his risk.  In fact, you can use a really great sounding title when describing the process, telling your client he’ll be implementing an “enterprise risk strategy” (which just sounds cool, doesn’t it?), which you will help him develop and put into place.

And I’ll leave you with that cliffhanger until next time, dear reader, when we’ll learn about developing this program (which will be off the record, on the QT and very “Hush, Hush – wait, that’s Sid from L.A. Confidential ….)



About Hale Stewart

Hale Stewart is a tax attorney, in Houston, Texas, which you’d think would make him boring and dull.  However, his wife assures people that he’s really very funny. Their dogs aren’t quite so sure. He is truly a tax nerd – he has a masters in U.S. and international tax, has actually read the entire tax code multiple times along with more cases than should be allowed by law.  He’s written a few books on Captive Insurance and has been working in this area of the law for over a decade. Please help him make Captive Insurance in Plain English a NY Times bestseller by buying it.

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