Concept may have applicability for corn, soybean and wheat producers
Producers might actually profit from owning their own insurance company. A concept that until recently was largely used only by agribusiness and large farmers in California, captive insurance might have applicability for farmers in the heartland.
"In California, a lot of growers have captives," says Gordon Schaller, a partner in JMBM’s Tax and Estate Planning practice in Irvine, Calif. Many agribusiness companies, such as ADM, Cargill, Dairylea Cooperative and Growmark, also have captives. The use of captives by private agricultural firms has been growing in recent years.
Captives are not just for large firms and mammoth California growers, however. Schaller believes captive insurance offers opportunities for corn, soybean, wheat and other growers, but that they are not used because growers are not aware of their potential.
Captives are certainly not for everybody. "Farmers need at least $10 million in sales to be large enough to consider a captive," says Karl Huish, senior vice president of Artex Risk Solutions and leader of the company’s small captive division in Mesa, Ariz. Beyond revenue, farmers also need insurance premiums of $100,000 or more or profits of at least $1 million to justify owning a captive. Those minimums are due in part to the cost of setup, licenses and policies.
"I have written a number of captive policies for farmers in the $10 million to $20 million range," Huish says. A captive can be used to insure a number of risks that farmers face, including crop failure, product recall, environmental issues, workers’ compensation, auto liability and general liability.
For a stand-alone captive, a firm might need as much as $50 million in sales, but by becoming a "cell" of a sponsored captive, or by having 10 or 20 farmers form a captive group, smaller producers can still take advantage of using a captive, Schaller says. "Part of it is just knowing about the various alter-natives that are available," Schaller says. "They are not well-known among Midwest farmers."
Smaller producers can also make use of a captive through what is known as "rent-a-captive." The rent-a-captive is owned by a sponsor, so the individual farmer does not develop equity. With a cell captive, the individual farmer owns an independent cell, which is similar to a separate company.
Captive or Traditional? Why would farmers want to use a captive more than traditional crop and other insurance? Two reasons, Schaller says. First and foremost, the captive premiums are tax-deductible. Second, the premium, assuming there are no claims for several years, acts like a savings account. Furthermore, the premium money is protected from creditors. "You build up cash so you can do estate planning, and it is not subject to estate tax," Schaller states. "I like the idea of protecting assets," he adds.
One illustration of the advantage of a captive is that during the recent crash in the real estate market, home builders with captives could access the premiums they had built up and use them like a savings account, and the money was protected from creditors, Schaller says.
Another advantage of a captive is that it can insure against losses that are not covered by traditional insurance policies, such as claims of foodborne illnesses and environmental issues related to pesticides.
Producers can also use captives to insure against crop loss. Schaller believes that producers with a captive would still want to carry crop insurance for catastrophic loss, but use their cell to offset $100,000 per year in tax-deductible premiums to the captive. "You always want some traditional crop insurance," he says. If no losses occur for 10 years, the captive would contain nearly $1 million that could be used for other purchases or as a savings account.
Schaller says other advantages of a captive are that it can be changed at any time or discontinued.
The Downside. Is there a disadvantage to setting up a captive? Yes, Huish says. Farmers who experience several years in a row of large crop losses would have been better off buying insurance in the market, he says. There would not be enough money built up in the captive policy to pay claims.
Captive Insurance Defined
Captive insurance is an insurance company owned entirely by the policyholder. It primarily insures the risks of businesses that are related to it through common ownership. For example, the owner can form a wholly owned captive insurance company for the purpose of insuring his related companies. The insured businesses pay premiums to the captive in exchange for insurance. The captive can be owned by the business owner, his spouse, a trust or any of the companies he owns.
If the company insures only the parent and its clients, it is called a pure captive. Like traditional insurance companies, these are established to insure assets or ensure against losses from a contingent event.
In the past 20 to 30 years, the number of captive insurance companies has grown. Today, there are more than 5,000 captives worldwide, writing more than $20 billion in premium. These companies have capital and surplus that are estimated at more than $50 billion.