Learn How to Manage Risk with Captive Insurance

Van: I’ll try to keep it short. My name is Van Carlson, CEO and founder of Strategic Risk Alternatives. We’re 831(b) planners. What that is is no different than a 401(k) planner. 831(b) allows our clients to put away profits today to weather the storms for tomorrow.

Toby: Timely now, right?

Van: Yeah. We’re not shying away from the 831(b). Unfortunately, it’s been hit by the IRS the last couple of years. They’ve won some cases. You got to love the American people. Of course, I’m one of them. I do want to pay as little taxes as possible.

Toby: A little aggressive, huh?

Van: We’re like water. We’ll get a code, somebody will get smart about it, look at it, and go, wait a minute, it was intended for this, but maybe I can use it for this. We’ve always been fairly creative in that arena. It’s also what gives us our strength as a country, we’re innovators.

Unfortunately, the Tax Code was used as a tax planning when it wasn’t used for what it was originally designed to be, and that’s a risk mitigation tool. Very, very similar to what a lot of people experienced this past year of realizing that they’re buying an insurance policy from their traditional insurance carrier, and the concept is there is coverage for everything.

Unfortunately, you find out how good of a policy you have when you need it. I can’t tell you how many times when I used to sell property and casualty insurance that, oh, I got an umbrella policy. I’m covered for everything. Just because it’s called an umbrella doesn’t mean that it’s over the top of […].

Toby: Lawyer insurance. They’ll oftentimes provide you a defense under a reservation of rights, and then say they’re not really covered if they’re big […].

Van: Yeah, exactly. Everything’s in the fine print. Unfortunately, other clients read their policies this year or sought out advice from their agents and found out that pandemic coverages are not considered a coverage under the business interruption endorsement.

Toby: You see this every time? I don’t mean to interrupt you, but I’m just setting the table up for people because some people have never heard of captive insurance. They don’t know what we’re talking about.

Real quick, it’s basically being able to set up your own insurance company—that means it’s captive—you own it, and you’re paying it premiums that you deduct. Basically, the insurance company doesn’t have to pay tax on the premiums.

Van: Correct.

Toby: The money goes in and it can continue to be invested. There’s a risk pool, and you’re able to put this thing together, but you have very strict requirements on what type of risk you could insure. That’s what I’ll ask you, man. Who is this for? What type of risk could it insure?

Van: Risk is not a problem. I can’t reiterate that enough after 2020. Our clients are successful business owners—fairly advanced in their thought processes and more forward-thinking. They recognize the risk they’ve taken to run their business and how they mitigate that risk.

You can’t just keep doubling down on things. You can’t keep getting bigger for the sake of getting bigger. There are strategic things that you have to do along the way. Anytime you can close out the gaps in the back room on risk, that’s just good business management.

Our clients from every industry you can think of—we have a lot of substantial and mathematical clients. Obviously, they understand asset protection and the risk it takes.

Toby: Let’s give them an example. I don’t mean to interrupt you, but I want to make sure that anybody can understand this. I go out, I get a regular insurance policy for my health and things like that. I get a regular business policy. If I’m a physician, maybe I have E&O—Errors and Omission. If I own my own business, I’ll probably have some coverage for employees in case somebody sues me.

Van: Yeah. A slip and fall policy, walk in through the front door office policy—stuff like that.

Toby: That’s not what this is.

Van: No. God, no.

Toby: This is saying, hey, there’s basic stuff you could insure, but there’s a lot of stuff you cannot get insurance for.

Van: Toby, a good example is when we first started designing policies around HIPAA violations. At one point, the policies wouldn’t cover general liability policies when a doctor got them for the practice or even their cyber coverages. If there was a cyber breach and there was a HIPAA violation, states started to enforce those. States started enforcing those on what they perceived to be abusive or gross negligence on behalf of the medical practice. There was a pretty heavy fine level. The insurance company wasn’t paying that fine.

When we first started looking at risks for medical practices, for example, we were looking at that. We really came down to political risk. Then last year comes along and now you got even more political risks because who is telling you to shut down? It was the cities, the state, and local governments that were forcing medical practices to shut it down.

Now, you have a political risk occurring where there is no direct physical loss on the property and how is business interruption going […]? If you got one of those office policies, my practice caught fire, I had to relocate, and just shut down for a month to rebuild—

Toby: I’m going to have deductibles.

Van: Actual physical loss. The business interruption policy is going to treat you very well. It’s going to pay for your employees. If you had a loan on the building, it will even pay the loan on the building. But if it doesn’t have that direct physical loss, you’re all on your own.

Toby: In COVID, they’re not covered?

Van: To give you a little history on that, in 2009, the SARS cases were occurring. Actually, Chubb Insurance lost the court case because the language in the policy was saying it’s excluded on the coverage, and the court ruled against them. What happened right after that? Every insurance carrier out there made sure it was very clear. It says anything that’s deemed to be a pandemic is excluded under the business interruption policy.

We’ve got a lot of court cases going on right now. Attorneys do what attorneys do. Every little word starts to mean, oh, this is the way I’m interpreting it, in which way are you interpreting it? Can we get to the judge and can we get a settlement?

There have been a lot of lawsuits, and there’s going to continue to be having a lot of lawsuits. For the most part, for what we’re seeing—at least here in the United States—all of them are being kicked out by the judge saying there’s no merit to bring a lawsuit forward based on the language of the policy. The insurance companies are winning, no surprise.

Toby: The plain language is pretty clear in a lot of cases. There might be outliers. There may be somebody who has a policy that was poorly-worded, but what you know is that it’s not going to be big—that there’s an argument for both sides. For the most part, they covered themselves against things like these.

Let’s assume you don’t have coverage. Let’s assume that you’re not going to be covered if you have an employee who gets somebody sick and that person gets somebody else sick. If somebody ends up suing you because you gave them COVID and right now, there’s no liability protection against it. All of those things are popping, what do you do?

Van: You’re going to find out real fast. There’s a thing called the right to defend on liability policies. It’ll be interesting to see that even if there’s no coverage but you’re being sued, a lot of times, the general liability policies will cover the legal defense. That’s going to be interesting, but that doesn’t mean they’re going to payout.

The point I’m trying to make is that the beginning of that is just starting to happen. I think lawsuits are going to be the next big thing we’re going to see under this COVID, or if they are contracted.

I think work comp policies are going to handle your employees pretty well. But if your clients, the guest of your restaurant, and the patients you have to the medical practice can prove that they contract the COVID in your location—if Congress doesn’t do something or something doesn’t happen sooner than later, this will go on the courts. You may have a policy that will cover you for the legal defense. It’s going to come down to case precedents because it’s not just COVID—that people contracted COVID.

A good example is the Norovirus in cruise ships. When somebody gets Norovirus from a cruise ship, they go to a restaurant, and they contract it there, typically, the liability policies have responded and covered the loss of wages of the person that was sick for a while and all that stuff. But at the level, we’re talking about today, especially the amount of deaths that are occurring. I don’t know if insurance companies are going to be so anxious to want to bite off on that.

It gets back to why you have to have these types of tools where you’re self-insuring risk, IRS says, hey, you can’t just take a dollar and set it off to the side. It’s really similar to 401(k). If I want a retirement plan for myself and my employees, and I just said, hey, I’m going to offer this retirement plan. I’m going to put this dollar over here, in the eyes of the IRS, that’s not a deduction.

However, if you utilize the Tax Code 401(k) and you have rules and regulations set forth—you got to have an investment test, your risk or rules, everything that goes into that—then you can deduct it. There are max contributions and mandatory distributions as well. As long as there are rules involved, the IRS will allow you to set these funds aside for your employee and your self-retirement.

831(b) allows you to set aside, again, you got to have rules in place, how much can I fund this for, what are the distribution rules, how is this set up, do you have an administrator—all those types of things. That’s what we do. That’s why I said earlier, we’re like a 401(k) planner, we just happened to be on an 831(b) Tax Code. I really want to make it as simple as possible for business owners to understand it.

There are two Tax Codes that allow you to defer income out of your business. One is the 401(k) for the retirement of yourself and your employees, and the other one is an 831(b) that allows you to build up reserves, take profits today, and be able to weather storms in the future. Believe me, there are lots of rules and regulations at it.

Toby: Let’s go and […] it. In a 401(k), I can put in—per employee—$50,000–$70,000 a year, get a deduction. How much can I put aside in these 831(b) plans?

Van: It’s going to be based on the gross revenue of your practice. Typically, the first couple of years will allow you to put in more on a percentage basis. Just know that there’s a formula to it, there’s a methodology to it. We certainly give the clients a cap on what they can max contribute. It really depends on the industry, it depends on a couple of different variety of things. But it’s all about building that for a rainy day fund.

There’s also something we call the four-part test. Again, this is what we do. We do the transfer risk, the risk distribution, we insure only things that can happen by accidents—we’re not insuring business risks. Every one of these tests is very detailed. We have good videos and all of those things to explain to business owners and clients. Then the last one is you got to act in a principal’s insurance. That’s our job to make sure our clients are doing all four of those things, to meet that test in order to elect under 831(b).

We’ll give the clients the determination of premiums. After five years that we keep funding, they don’t have a lot of claims, we’re going to require them to do a solvency test. These are things that you learn along the way with us as business owners, but just know that we try to make it as simple and as clear to our clients. We’re not here to complicate their lives by owning one of these vehicles.

To me, I always tell business owners, listen, if you’re having a good year, even a mediocre year, or whatever, and then take a little bit off the top and park it off to the side, this is good risk mitigation. If you’re doing this deduction for a 401(k) for retirement and for yourself, it would seem a little crazy to me if you don’t want to do this for your own business.

Toby: Let’s make it real. You mentioned the doctor, but this could be any business, right? This doesn’t have to be a dentist, doctor. It could be a builder. I’ve seen some pretty cool policies.

Let’s just say that I’m making a couple of million dollars a year. I have extra cash. I’m growing my business. I’m a little bit worried. Hey, in the future, I want to make sure, because I know in this type of business—you’re a doctor—you’re going to get sued. In my practice, I know there are going to be issues. There may be issues with employees, there may be issues with doctors I hired—whatever, fill in the blank, I may have issues. I could put aside my war chest and deduct it. Is that a fair statement?

Van: Yeah. Let’s make it real. If you said to me, hey I have a $3 million a year practice. We’re going to give you a ceiling of 10% in the first year on a gross revenue basis.

Toby: I can put $300,000 a year in stock?

Van: Yeah. That $300,000, we’re going to tower it into different risk profiles. We won’t allow you to go in 2% of that any one policy. Again, this is a formula that we own, it’s our methodology. We’re trying to be somewhat a conservative approach with business owners of what the expectations are. You could put up $2.3 million a year into these programs.

Toby: That’s the ceiling. If I make $2 million, I can’t just put $2 million in it, right?

Van: Correct. That’s why we cap it at 10% of your gross revenue. This is really how insurance companies work. All they care about is your gross revenue. If your gross revenue goes up, guess what’s going to happen? Your premium is going to go up too. The idea is the more gross revenue you have, the more exposure you have for claims. That’s the determining factor.

Toby: If I’m grossing $10 million a year, netting $1.5 million. There’s the doctor and they’re like, oh my God, I’m getting killed in taxes. I’m having $1.5 million, at least $1 million of it is in the highest bracket, I’m just getting crushed. In that particular instance, $10 million, they could put some percentage, 10%, so I could put $1 million into a policy, and I could deduct that. My $1.5 million just becomes $500,000 from a tax standpoint.

That $1 million goes into a policy, what happens to it then?

Van: More likely, it will probably go into several different policies on a percentage basis. A good example would be dispute resolution. Also, we look at doctor’s malpractice policies—what we’re seeing is a big tick up on deductibles on traditional policies—and we’ll also look for gaps. Unfortunately, there are a lot of gaps in malpractice insurance today. If anything, it’s getting worse from that. I say gaps, really, they’re adding more exclusions which creates gaps.

Toby: In figuring out where their liability is and making sure that they’re not paying for it.

Van: They can’t charge so much for you to say I can’t buy it anymore, I can’t afford it. They would love to charge you as much as they could, but they still got to keep the policy competitive and price right where you’re willing to buy it. That’s why the policy keeps getting thicker every year. It’s not because they’re adding coverages, it’s because they’re excluding.

Toby: They’re getting experienced in what’s hurting them, and they’re making sure that they’re still making money. You said dispute resolutions. That’s like, if you’re settling cases, if you’re meditating things.

Van: Yeah. What we see in the medical practice a lot are employer liability claims where they’re being sued for wrongful termination, sexual harassment. It’s very difficult to get coverage a lot of times in the medical community because they have a tendency to have higher than average claim ratios in that situation. We’ll put a policy together for that.

Supply chain risk, flu shots, I guess COVID vaccines are next. If you have a distribution of supply chain risk that […]. We had some issues come up this past year with plastic surgeons. We’ve got several plastic surgeons as clients and they needed certain things in order to do what they need to do in order to stay open and do their procedures.

Toby: They made a claim against their own insurance.

Van: Absolutely. We saw a lot of those claims. We saw little practices that were shut down that triggered political risk. Also, I think all the third party business interruption today is huge. If I’m dependent on my CRM system that holds all my information up in the cloud, and they get compromised due to cyber or I just can’t get into them anymore for whatever reason—they got locked out—or they found out one of my key employees hit the Capitol building and now they shut me off.

The cancel culture we’re in today is detrimental to your businesses, and how do you react to that? You better have a bucket of cash sitting around to be able to do them because the banks aren’t going to help you out all of a sudden.

Toby: I put this money aside, am I ever going to get it back, is it gone?

Van: Absolutely, no. You’re the shareholder of the company. After one year, one day, you could declare a dividend, you could take it out as a long-term dividend rate. You could shut it down, pull out capital gains, or you can put it to work.

Toby: This is where it gets interesting. I put my million dollars—what I want you guys to understand is that it’s a deduction against your ordinary income, but when it’s taken out, it’s treated as a dividend which is taxed as long-term capital gains.

If you’re in the highest tax bracket, you’re 37% right now but possibly going up to 39.6% depending on […], you’re guaranteed to be in a lower rate of capital gains, which will be 20% and they’re talking about dealing up to 28% for people over $1 million. Let’s just say that you’re still going to save 10%–11% on the dollar even if you took it right back out a year later. Is that fair to say?

Van: 100%. Obviously, we do have clients that do that, but most of our clients hand it over to the financial advisor and they manage the money. It’s like a 401(k), would I rather use pre-tax dollars to invest or after-tax dollars?

Toby: This is really, really important because in a 401(k), I’m forced to do whatever their five options are or something. Are you going to stick people and say, hey, you can only do this type of mutual fund or whatever? Can they just go trade away, could they go do the AMC?

Van: There’s an investment agreement. What can they do with the reserves, we just tell people—I know you’re mostly in Vegas, but you can’t just go bet it on red in the roulette. There are rules to the investment strategies. But for the most part, of course, we have a lot of clients that just leave it to the bank and go forward with the risk.

I talk to clients. The reason why Congress even has this Tax Code is no different than the 401(k). If it wasn’t a deductible at my company level, would I offer retirement plans to my employees? Not unless they were all your grandkids, but I can’t imagine offering a retirement plan and not be able to deduct it.

The 831(b) is too. It’s called creating an incentive, and incentives are designed to create a certain predictable behavior. Congress came out with 831(b) in order to create a behavior. This was back in 1986—I should add—that farmers are self-insuring their risks for crop insurance. That’s why the code started out. With time now you’re talking over 30 years. It’s evolved in a lot of other ways.

Toby: I think they had three layers of tax that people were getting hit on and they said, hey, we got to cut back one of the layers.

I remember digging into this long, long time ago going wow, what they’re trying to do was basically allow you to not get completely decimated if you’re trying to insure some of these things.

Van: That’s a good point. Congress loves this tax cut. They think it’s a way for business owners to survive. The biggest tax collected in our country is still payroll tax. They want to keep these businesses open. They want jobs.

Toby: Let’s say that your practice gets decimated by COVID. You have one of these policies. Do their creditors get to just go take this policy, or is this something that is still your company outside of the business they could shut down?

Van: We had those conversations. Unfortunately, we got to be honest with everybody and answer the questions that are asked. But absolutely, they don’t know that these things exist.

Toby: It’s an insurance policy and you own the insurance company. You’re an individual, you own the insurance company. I guess they could try to take away your interest in the insurance company.

Van: They could be the ones to pull the claim and get all the money. There are a lot of strategies that we work with individual clients on, and we tell them the good, the bad, and the ugly. Sometimes, it is ugly (unfortunately) if they’re in a bad situation.

I tell clients all the time that if you’re using insurance, I don’t care what kind of insurance it is, you’re not having a good day. I don’t care if it’s your auto insurance policy, your homeowners, or your office policy. Of course, I always joke and I say the worst one is life insurance especially if it happens to be your life. Then none of it is a good situation.

Toby: He’s claiming, come on.

Van: One of the best compliments that we can get doing what we do for a living is when our client says, Van, I’ve been with you for several years, I just sleep easier at night knowing I’m in your program. I think that’s a great compliment for our business, for our industry is we manage risk in a way that allows you to sleep a little easier at night. Unfortunately, last year if I had to guess, a lot of business owners slept a little easy last year. Much more so than the previous years.

Toby: But you still had the pot of money set aside. This is the idea. This is why I really wanted to talk to you. You’ve been on before and we look at this. You have the insurance company you’ve set up, and then there’s an insurance that you’re actually making claims to. You can go to a third company that’s floating around in there.

Van: There’s a float. It’s ours actually, but yeah.

Toby: That’s what it’s doing. Frankly, that’s why you’re here. Because a lot of people are trying to do everything all in one and you get a little bit of self-serving stuff going on. We want to go conservative. So there is a separate company that’s actually an insurance company. You own your insurance company, but the premiums, somebody else goes through a third party—Van’s company—when you make claims.

The whole idea is that you’re putting funds aside for that what-if moment, and if we’ve ever had a what-if moment, it was in the last year. It’s like the wake-up call. Before that, the what-if moment was 2008 and 2009. Then, you had this crazy stuff going on in buildings so builders are going nuts. It’s like, hey, guys, you’re going to have claims about roofs, about what you build, you’re going to have workmanship.

It comes three or four years later. It’s going to come, but it’s going to come a long time. Put the money aside now. If I just put it aside in my savings account, I’m still paying tax on it so I’m losing up to 40%. This allows me to put it aside and I can deduct it.

Van’s services aren’t free, but you do the penciling it out. When you look at the stuff, the growth should more than offset any cost, and you’re keeping 100% of the dollar as opposed to $0.60 on a dollar. Is that a fair assessment, Van?

Van: Absolutely. In the way we structure it, our clients actually get their buckets of money substantially larger. If you have to use the coverages that we’re talking about, that you’re self-insuring risk for the day, that you can’t buy traditional insurance policies to transfer that risk, you actually get a bigger bucket of money than the dollar you put in.

Again, there are all these videos that we have in education. There is a learning curve to this program. It’s not easy. Unfortunately, it’s not like a 401(k) where it just becomes a normal business practice and everybody’s doing it. I would say a lot of you business owners still don’t know the rules and regulations of the 401(k) either, right?

But when it comes to the 831(b), there is obviously a knowledge process, a learning curve that we want to get our clients through, and we do a pretty good job with that. Like I said, we’re not here to complicate their lives. But at the same time though, again, it does make our clients sleep easier at night.

The ones that were involved in our programs last year—we had a substantial amount of claims last year.

Toby: Against their own policies, right?

Van: Yeah. They were very thankful. I could tell you this, we were paying claims out before PPP was, before the Federal Government was. We were sending money out to clients right away under a thing called the facultative clause.

From our standpoint, we didn’t want COVID to happen. It became real last year for a lot of business owners. Nothing’s slowed down. We had a fantastic year last year. We ended the year with a record year. We really didn’t know what was going to happen.

This time last year, everybody was betting on what was happening. I think we just started our first cases of COVID here in the United States. But by March, it was a weird time for sure. It was a new time with us.

Toby: When the State started closing businesses down.

Van: Yeah. Forced you to stay home and work if you could. Anyway, we didn’t know how it was going to end. But man, we ended up a record year for us. The conversations haven’t stopped.

We just talked to a client here about a week ago, a pretty great construction company. He does construction all over the country. He said, “Had you guys talked to us a year, a year and a half ago, we wouldn’t have known what you’re talking about. But then here comes COVID along.” His comment to us was, this makes too much sense not to do. We feel this will become a normal business practice. The insurance industry is not going to increase its appetite for risk. If anything, they’re going to continue to contract it.

Toby: They’re going to have to.

Van: Yeah. You’re not going to buy a policy where it’s so darn expensive. You’re just not going to buy it. At some point, you’re going to call […].

Toby: They have to […]. If it’s a sure thing, it’s a sure thing that they probably can’t cover—

Van: Or they’re going to back it down or exclude it. I got a policy, but what’s it really worth? I’m not blaming the insurance industry. I think they do a good job of what they traditionally do.

Toby: They calculate things. That’s why they have insurance.

Van: Think about brand damage today, think about supply chain risk, think about dispute resolution. Dependent on third-party vendors—it’s not just that I can go and unlock my door, open it up, and open myself up for business. Now, I got to be able to get on to my […], this independent, third-party cloud service. Be able to get in there, reach in, and get my client’s information. I don’t have a hard file anymore that I can pull out, you know what I mean?

The rules change so much in the insurance industry. They refuse to recognize that, or they just don’t have any interest in it.

Toby: We know the cyber stuff. This is a thing that breaks my heart.

Van: Cyber’s huge. Cyber is scary.

Toby: Yeah. One morning, you wake up and they’ve crashed your system. There’s more hacking than you realize. It’s like, oh, great. What happens if my database gets—

Van: We offer a really robust cyber, especially with business interruption under cyber policies because you may have a good cyber policy that protects your client’s information and a forensic team that says, okay, how did this happen? But that doesn’t mean the local news media didn’t report on your business. Now, you have brand damage happening. Also, you’ve got to build your reputation up in the public. Well, where is that money going to come from?

I call that the double negative where if my expenses are going up but my income is going down, am I going to be able to go run to the bank and say, hey, I need to get a bigger line of credit from you. No. This is just risk mitigation. By the way, this is what big companies do. They just happen to have a fleet of attorneys and a fleet of risk managers.

Toby: Didn’t McDonald’s make it popular because of the Happy Meal? You put a hamburger and a toy together. The toy is just perfect to get choking on. Nobody’s going to insure that, so they have to go insure it themselves.

Van: All of these big companies. They didn’t care about the tax deductions. Who’s selling Microsoft product liability, right? They have to self-insure the risk.

Toby: If you’re public, you can’t show the profit. This is the thing. A lot of the time, they don’t want to get in trouble, so they need to have the deduction so they’re not having shareholders beating them up. Because if they said, hey, we’re going to put 5% of our revenue aside for a rainy day, you’re going to have shareholders screaming at you to pay it out. As opposed to if you’re paying it out as an expense or something.

Van: The nice thing is it still ends up as an asset to the company.

Toby: It’s still in the balance sheet, but it’s not a net profit.

Van: This is great risk management that lets you sleep easier at night. I know it could be a lot more and it could sound very complicated and confusing at times because it’s insurance, how excited can we get about that? Once your listeners really know and understand that we have a simple process, we’re not here to complicate their lives.

Every business owner, every risk-taker out there—a risk-taker that’s willing to calculate the risk, and then do it or not do it. Nobody just blindly goes into something because you’re not going to last very long.

We explain a lot of things to clients, but you definitely owe it to your business, employees, and community—the community wants you to stay open—to manage your risks the best you can and utilize all the tools available. To understand a little bit of what we do would go a long way in mitigating all those things and allow you to sleep easier at night.

Toby: Let’s do this. I’ll post your information with this video, so I’ll put it in the bottom third, or I’ll have my guys put it up there. If anybody has any questions, it’s Strategic Risk Alternatives. You’re up there in Boise, Idaho, right?

Van: Yeah. Good old, good old Boise.

Toby: I’ll put all your information so that they can reach out. You’re the appropriate person that they should talk to, or do you want us to give us some other contact?

Van: If you go to our website, you’ll see our team and our sales team. I’m always happy to educate. Like I said, we have really good educational videos, we’ve dumped some money into those because people want to watch and learn things at their own time. We get that. We did a pretty big investment into that. That’s been beneficial for everybody. We’re happy to share those with whoever wants to see them.

Toby: Perfect. Thanks for joining me today. Appreciate it.

Van: Thank you. Always a pleasure.

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