How captive insurance can save high net worth clients’ hard-earned money

By Randy Sadler

Financial advisors wear many hats: balancing clients’ financial wants, needs and goals with the realities that markets present, and managing clients’ subsequent expectations and reactions through thick and thin. Those demands are compounded and more complicated when working with high net worth clients. This is due to constantly changing tax codes, estate planning, lifestyle expenditure planning and general wealth protection that HNW clients consider as major concerns. Asset Mark also cites specialized support, advanced technology offerings, effective withdrawal/wealth transfer strategies, and risk management and protection as important to HNW clients.

In addition to managing NHW clients’ funds, finding the right protection and coverage options for them poses a challenge given these clients’ level of market exposure. These increased exposures are seen in more robust portfolios and from the prevalence of the sharing economy in today’s marketplace (i.e., HNW individuals renting out properties to make additional income on investments like second homes or beach properties).

Although the traditional insurance market is effective in safeguarding basic business needs, high net worth clients typically face unique risks that aren’t covered within a traditional policy — or that traditional policy may have gaps or exclusions. For example, HNW individuals face risks such as loss of a key contract, copyright infringement or even issues with reputation damage. Also, the lead time with establishing traditional insurance policies is long and takes 12-18 months on average to release new insurance products.

Considering the amount of threats and new regulations HNW clients potentially face in that time, the risks are compounded by a slow system that is now charging more in premiums, as reported by KFF. Gaps in a policy are areas of potential risk when a HNW client needs more coverage than what is currently offered by the insurer.

Then, there’s the challenge of costly, skyrocketing premiums. Although clients can almost always benefit from more insurance, it’s a sunk cost as the premiums paid with no claims materializing feels like money right out the door. Captive insurance, however, offers a solution to these dilemmas as well as a few other key areas of interest for HNW clients – giving advisors yet another way to give their clients the “win” they’re looking for.

Captive insurance: an oasis for NHW clients

A captive insurance is a form of self-insurance and owned by the business or business owner that clients or their businesses pay premiums to each month just as they do to a traditional provider. The difference is that instead of acting as a of sunk cost with traditional premiums, captives retain the premiums paid and over time the premiums paid minus claims build a profit center.

A captive insurance policy supplements a traditional policy by filling the gaps since the policies can be tailored to a client’s unique risk profile with stable rates for their insurance premiums.

For HNW clients in heavily regulated industries such as construction, medical and manufacturing fields, insuring their risks with a captive is a great option. Especially considering that regulations change and oversights or mandatory changes in business structure result in steep penalties.

That said, captive insurance and setting up a captive subsidiary is an involved process that frequently requires help from a third party to set up. Included in this process, captive insurance has start-up costs and capitalization requirements such as formation fees as well as legal costs —since captives are a legally formed corporation.

Additionally, captive insurance builds upon existing risk mitigation strategies to accrue funds for possible losses. If these plans do not fully encompass an organization’s risk exposure, then the vulnerability to unforeseen losses increases. Firms that assist in the set-up of a captive also manage the day-to-day operations of the captive and ensure HNW clients and advisors don’t have to deal with any additional responsibilities.

Succession planning

HNW clients need a sophisticated and diversified plan in place for their estate planning process. With a captive insurance company, clients have several key estate planning structures organized and housed within that one captive subsidiary. These include state income tax protection trust, an asset protection trust and an estate/generation-skipping trust or dynasty trust.

Similar to providing a tailored fit to HNW client insurance plans, captives make it easier to fight off the top risks of estate planning for HNW clients. Those risks include not being up to date with their estate plans, passing down a family business, underestimating estate taxes and picking the wrong trustee for one’s will. With a captive, the team that operates it should be diversified and filled by individuals unaffiliated with the parent company so to promote independent and fair dealings between captive and parent company. All of these help ensure these risks don’t become realized.

To hammer this home, here is a hypothetical given by the Journal of Accountancy. If a doctor set up a trust and contributed money to it, the proceeds from that trust, upon liquidation to the doctor or his beneficiaries, would face a tax consequence upon the liquidation but no tax deduction upon the contribution. With a captive, the tax consequence comes from the captive and insulates the proceeds of the trust. This narrows the complications of HNW clients distributing their wealth. Which, according to Page 11 of a report from JMBM, makes captive insurance a great fit for those in the estate planning process.

Looking ahead

Setting up a captive insurances subsidiary for HNW clients is a great consideration as we move through 2023. With the opportunity to combine expansive insurance protections, succession planning and retain premiums that go toward turning a captive into a profit center, captive insurance may be idea for your HNW clients this year.

Randy Sadler is a principal with CIC services. He may be contacted at [email protected].