Traditional risks such as Commercial Property, General Liability, Workers Comp, etc., are almost always covered by Commercial insurance policies. But what about “Non-Traditional Risks” such as Business Interruption, Data Breach, Warranty & Service Contracts, etc.? More often than not, small to medium sized businesses (SMBs) have funded these “Non-Traditional Risks” with operational cash-flow, using after-tax dollars! This approach is always a roll of the dice, but there is a better way!
Many small to medium sized businesses are finally discovering what has been traditionally reserved for the “big boys”, by way of establishing their own insurance company. These insurance companies are referred to as micro-captives, designed under IRC 831(b). An 831(b) captive insurance company is a small insurance entity that is specifically designed to insure the risks for its’ Parent company. It provides the full dollar for claims, ensuring that the parent company is adequately protected. The premiums paid are tax-deductible for the Parent company and the premiums received by the 831(b) qualified insurance company are tax exempt; thus, making it a cost effective and efficient risk management tool, especially for managing below the surface risks that are not typically covered by traditional insurance.
Here are a few common below-the-surface risks not covered by traditional insurance that could severely impact or cripple the success of any small business if more than one happens at once:
Business Interruption: The government’s response to the pandemic highlighted this risk for SMBs in a way never before seen. These unforeseen interruptions resulted in PPP and ERC but in many cases, could have been mitigated with a properly structured micro-captive.
Data Breaches: SMBs often underestimate the financial impact of data breaches, hacking incidents, or malware attacks. These can involve hefty costs related to data recovery, system repairs, legal fees, and compensations for affected customers. Consider the average fines to a SMB with a significant data breach to equal or exceed $250,000.
Brand and Reputational Damage: Damage to a business’s reputation, possibly due to a malicious negative review, can result in significant financial losses from decreased sales and the high costs of reputation management and marketing to rebuild trust.
Loss of Key Employee or Key Client: The loss of a key client or tenured employee, especially unexpectedly, can disrupt operations and necessitate immediate and costly hiring or training expenditures to fill the gap.
Contractor Default: When a major contractor/subcontractor fails to pay for services or products delivered, especially if a significant portion of revenue depends on them, the financial impact can be severe.
Product Liability and Recalls: For businesses that manufacture products, the costs associated with a product recall or liability claims due to defective products can be enormous and are not always fully covered by insurance.
Legal or Audit Expenses: If you are successful in business and haven’t been sued or audited, you can plan on that happening in your lifetime as an owner in one of the most litigious societies on earth. Prolonged legal defense or audits can drain operational cash flow and savings quickly. Disputes among business partners or major stakeholders can lead to drawn-out legal processes with substantial legal fees and potential settlement costs.
Regulatory Audit: Fines and legal fees associated with failing to meet new or existing regulations can be substantial. This includes changing health and safety violations, environmental regulations, or industry-specific compliance requirements.
Supply Chain Interruption: Uninsured losses due to supply chain issues, such as the loss of a supplier or increased costs due to scarcity of materials, can significantly impact a business’s ability to operate and deliver products or services.
Deductible Reimbursement: High limit deductible policies are becoming more cost effective, especially with the drastic increases in premiums for traditional coverages. However, the negative impact to operational cash-flow when a claim arises can be a significant hindrance to the overall viability of the business.
Warranty & Service Contracts: Most SMBs fulfill their warranty claims with operational cash-flow or set aside monies in an after-tax manner. The efficiencies of a warranty captive, similar to auto dealerships offering extended warranties, allow for honoring those warranty claims in the most economically efficient manner.
Below-the-surface risks and liabilities are particularly challenging because they often require large outlays of cash at short notice and can significantly strain a business’s financial health. SMBs, therefore, need to be proactive in identifying potential vulnerabilities and consider alternative ways to mitigate these risks, including exploring alternative insurance solutions like 831(b) captive insurance ownership where feasible.
If history is any indicator, you may get away with no insurance for potentially expensive claims and liabilities a couple of years in a row however the law of averages says that sooner or later, you will have one or more expensive claims in succession.
If you own a business and would like to discuss the qualifications for a SMB captive insurance company and the types of specific coverages you can elect, you can reach one of our Risk Advisors at Safe Harbor Captives by emailing info@safeharborcaptives.com or scheduling a discovery call visit www.safeharborcaptives.com
The foregoing information is not intended to be tax, legal, investment, or property and casualty insurance advice and is provided for general educational purpose only. Neither Safe Harbor Captives, nor its subsidiaries, agents, or employees provide tax, legal, investment, or property and casualty insurance advice. You should consult with your proper tax, legal, and financial advisor regarding your situation.
