Thanks to tariffs, we have gotten a break from the ongoing media headlines that scream ‘Increases in natural disasters!’ ‘Hurricanes are getting more frequent!’ ‘Mass fire losses are becoming more common!’ ‘The icebergs are melting and we are all cooking alive!’
Even the governor’s mansion is not spared these days.
But what is a real estate investor to do to mitigate the never-ending rising tide of insurance costs?
For larger investors, syndications or property management companies with significant AUM, a Captive Insurance company can help return some dollars back to the investors.
What Is a Captive Insurance Company?
A captive insurance company is a licensed insurance entity formed by a business or group of businesses to insure their own risks. Instead of paying premiums to a third-party insurance company, the business pays premiums to the captive, which is wholly owned and controlled by the insured entity. The idea is to “capture” profits and gain greater control over claims.
- Think of Captive Insurance like a credit union. Similarly, it can be a shared pool for insurance, and any leftover premiums after paying claims are returned to the owner/members or invested for a profit.
Captives can be formed as pure captives (serving only the parent company), group captives (shared among several businesses), or cell captives (with legal separation but shared administration). Real estate businesses often opt for pure or group captives, depending on their size and scope.
Why Property Owners benefit from Captives
1. Cost Control and Premium Stability
Traditional insurance premiums can be volatile, especially in regions prone to natural disasters or when insuring older or specialized properties. Captives allow property owners to stabilize costs over time by managing risk in-house and retaining profits that would otherwise go to commercial insurers.
2. Improved Claims Handling
By controlling their own insurer, real estate owners gain better oversight of the claims process. This can lead to faster resolution, fewer disputes, and the ability to handle sensitive claims discreetly and efficiently.
3. Tax Advantages
Captive insurance companies that meet IRS guidelines may receive favorable tax treatment. Premiums paid to the captive may be tax-deductible (Unlike ‘Self Insurance’ which is not deducible) and the captive’s underwriting profits can grow tax-deferred, providing a return to the owners. This area is complex and requires careful compliance with federal and state regulations.
4. Incentivizing Risk Management
Captives reward proactive risk management. The better a company controls losses and mitigates risks, the more profitable the captive becomes. This aligns financial incentives with sound property management practices, such as routine maintenance, better tenant screening, and emergency preparedness.
5. Property Management Benefits
If you own a property management company, having a captive for your managed properties can help you in several ways.
- Works as a marketing tool to bring in new properties to your property management company. The owners will benefit from the lower insurance costs your return of premium provides from the Captive Insurance.
- Builds Retention for the overall portfolio. Owners will be reluctant to leave a Captive Insurance and go back to a higher priced marketplace.
How to Set Up a Captive for Real Estate
1. Feasibility Study
A property owner should begin by conducting a feasibility study with a captive management firm. This will assess the viability of forming a captive based on the property portfolio, risk exposure, and projected premiums.
- A Captive begins to make sense for real estate owners with portfolios typically paying $500,000 or more in premiums per year.
- The combined Loss Ratio for the properties in the Captive should be less than 40%.
- Example of Loss Ratio: 5 year average amount of losses/ by premiums paid
- Owner has 25 properties that pay $1M in premiums
- This is $5M in premiums paid over 5 years
- Claims paid were $2M over 5 years
- Divide $2M by $5M equals a 40% loss ratio
- Example of Loss Ratio: 5 year average amount of losses/ by premiums paid
2. Licensing and Formation
The IRS requires certain legal structure, and owners should make sure they are receiving quality legal counsel in establishing their new entity.
- The captive must be a private separate insurance company.
- The company must be a C-Corp or LLC taxed as C-Corp. With this structure risk is shifted to a separate tax paying entity.
- Must have a Dec 31st year end accounting.
- A Captive may only provide policies to their owners/members. An AM Best Rating is required to issue a third-party policy.
3. Operations and Management
Once operational, the captive collects premiums, pays claims, manages reserves, and complies with ongoing regulatory reporting.
- Many real estate owners work with third-party administrators or captive managers for daily operations.
Final Thoughts
Before pursuing a captive, it’s essential to consult with experienced professionals—attorneys, actuaries, and captive managers—to ensure the structure is compliant, financially sound, and aligned with your broader investment strategy. When executed properly, a captive can be more than an insurance alternative—it can be a cornerstone of a smarter real estate business.
If you want to grow into greater stages of freedom and control over your investments, contact us to discuss your strategy.
