What You Should Know About HFX Self-Funded Insurance.

An Enhanced Risk Management Business Solution

What is a self-funded insurance program?
A self-funded insurance program, also known as a “Captive” has many benefits for all sizes of business. This insurance option should be considered and established mainly for its risk management factors - the tax benefits should not be the primary driver behind this insurance option.

A self-funded insurance program, or a captive, is an insurance company established primarily to insure the risk of its parent company and affiliated organizations or groups. Comparisons are often made to self-insurance. While the retention of risk is the obvious similarity, a captive generally provides greater tax benefits. A company that self-insures incurs a tax deduction for premium contributions to the insurance company.

Just because a captive is considered an insurance company does not mean the premiums are automatically deductible to the parent. The IRS states that for a transaction to be considered insurance, both “risk shifting” and “risk distribution” must be present.

Risk shifting occurs when a person or entity facing economic loss transfers some or all of the potential loss to an insurer. Under FAS 113, for a transfer to be considered insurance, there must be at least a 10% chance of a 10% loss. Simply stated, there must be some chance for underwriting losses between premiums paid and the limits of the policy.

Risk distribution involves the law of large numbers where enough relatively small, independent risks are involved to reduce the possibility that one large claim will exceed the premium received and threaten existing reserves. The IRS has set forth several revenue rulings outlining methods by which captive owners can achieve sufficient risk distribution.

Reasons to Form a Self-Funded Risk Management Business Solution

The following diagram provides categorized reasons for setting up a self-funded insurance program.

To Control Insurable Risks

Traditional insurers are subject to the cycles of hard and soft insurance markets. During hard markets, insurance coverage is more limited and prices are higher. A captive is less susceptible to these fluctuations and offers the insured more control over underwriting and claims settlement activities.

To Capture Investment Income and Accelerate/Manage Cash Flow

There is a difference in the timing of when the insurer receives premiums and when claims are paid to the insured. Because of this difference, premiums collected are invested and reserved until claims are paid. Corporate systems retain the benefit of investment earnings on premiums paid, whereas in the traditional market this benefit is forfeited to an independent, third party insurer.

Potential Tax Advantages

Primary tax advantages for captives include the potential deductibility of premiums and deferred taxation of insurance income. Under certain circumstances, an insured may deduct premiums paid to a captive that are not otherwise deductible under a self insurance arrangement.

Safety and Soundness for Risk Management Programs

The captive insurance market is more formalized than self-funding insurance risk and has a regulatory framework to support the captive (for example, a requirement for annual audits and actuarial opinions on adequacy of reserves). This may provide a higher probability (whether perceived or real) of success. Alternatively, the formalized framework still allows for insureds to work within a flexible environment to meet unique and specific needs.

To Establish Better-Than-Average Claim Experience

Because premium levels are directly impacted by claims experience, a company that has established a favorable claims history relative to the average market is a prime candidate to consider establishing a captive to avoid subsidizing other insured businesses with less favorable claims experience. Since there is a direct financial benefit for improving claims experience in the captive market companies will put greater emphasis on controlling claims costs. As a result, companies may take a more direct role in safety programs and other favorable practices. Since a captive is a more formalized form of self-insurance, the captive may provide better tools for gathering data for cost control efforts.

More Information

For more information on HFX Self-Funded insurance programs, you can download and review the following eFiles in PDF format.

We encourage you to connect with an HFX Insurance Risk Management Broker to discuss if a self-funded insurance program is right for your business. Click here to visit the CONNECT page of our website or call 818.259.0440.