What would you do if your business lost 90% of its revenue in just three months?
Unfortunately, this was a reality for one of our clients in the pharmaceutical space that had been generating $5 million dollars in revenue each year. Thankfully, our team had helped them create a captive insurance strategy before this happened.
So what is captive insurance?
It’s basically an insurance company that you own and control. When you pay a premium to your captive insurance company, though, it gets mixed into the pool of other people who have similar captive insurance companies.
Why captive insurance?
The purpose of this type of captive is to insure very specific enterprise risks associated with your business. For example, the loss of a major client or the loss of revenue due to a significant change in regulation. Captive insurance covers significant, but infrequent events, and represents an effective way to self-insure, especially for risks that traditional insurance companies will not cover.
In addition to the business risk benefit, these kinds of captive insurance companies also benefit from fantastic tax benefits. Section 831(b) of the Internal Revenue Code states that the premiums paid to qualifying captive insurance companies are deductible to the company paying the premium (yes, this is good!), but the income is not taxable to the captive insurance company (yay, this is even better!).
Our client appreciated the captive insurance from an income tax perspective, but they were primarily focused on the insurance benefit. They knew they had a very significant customer concentration that could heavily impact their revenue. They weren’t sure this was going to last forever so they needed a way to insure that risk.
The Strategy That Saved Business
Our team helped create a captive insurance company for our client and they paid a premium of $1.2 million dollars for two years. At the end of the second year, the reimbursement rule had changed and our client went from $5 million dollars in revenue to $600,000 dollars. Ouch!
This type of event was exactly what we were insuring against, though. We recommended they file a claim, which got approved and not only did our client get their money back from the captive insurance company, but they filed a claim for $1 million dollars, which was fully reimbursed.
Altogether they took $3 million dollars out of the captive insurance company, not including investment income. On top of that, their tax savings from this strategy were significant – about $500,000!
The Tembo Team is here to help our clients protect themselves against risks so that if something does happen they can be prepared and will always have a safety net to fall back on.
