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Private Insurance One Answer for Florida’s Coverage Crisis

By: James P. Landis & Rick Eldridge
May 31, 2007

Florida commercial real estate investors, builders and developers are acutely aware of the insurance issues facing them each day, particularly with respect to the lack of adequate wind coverage in an industry that has reported record profits over the past several of years.

The result of recent hurricanes and the “tightening of the insurance market” is that the Florida commercial real estate industry is now forced to self-insure more and more of their insurable risks.

One challenge facing everyone is how to plan for the next natural disaster. If the insurance industry will not provide adequate coverages, how does one prepare financially for uninsured losses? One way is to simply reserve for future losses on the balance sheet, but that method offers few financial benefits and ties up assets that could otherwise be put to work profitably.

There is, however, a partial solution to these problems as a result of new legislation in many states, as well as recently clarified tax rules. Today more than ever, it makes sense for profitable commercial real estate businesses to form their own private insurance company to better manage a variety of self-insured risks, including wind, environmental and liability.

A private insurance company is truly “private” when the shareholders, who own both the operating company and the insurance company, can control the types and amounts of risk assumed by the insurance company.

The beauties and benefits of establishing a private insurance company are multifold: self-insurance buffers a company against the often laborious and nebulous elements of the insurance industry; self-insuring is more cost effective; control of a company’s risks ensures hands-on direction of a company’s destiny; and, over time, the new entity can be a growing financial asset by capturing underwriting profits and the investment income that is typically passed on to the third-party insurers.

With recently clarified tax rules, commercial real estate entrepreneurs can now capture tremendous financial benefits from owning a private insurance company. These rules (based on over 20 years of case history) allow businesses to fully deduct up to $1,200,000 in annual premiums paid to its own private insurance company - yet that insurance company will not pay any taxes on those same premiums. In effect, an owner can transfer funds to the insurance company for the purpose of creating a pre-tax reserve against future losses, while at the same time reducing income taxes.

Furthermore, many states have enacted legislation allowing for the formation of private insurance companies and are competing for this business. The domestic requirements for licensing are thorough, ensuring that the new company is truly an insurance company in every sense of the word. As a result, businesses no longer have to go “offshore” to form these types of companies and face additional risks.

Until recently, this opportunity was available only to the largest companies in the world. The situation has dramatically changed and, as a result, mid-sized organizations now have the opportunity to reap tremendous benefits that were previously unavailable to them.

In Florida, most real estate lenders require that borrowers carry insurance coverages against wind losses. If the insurance industry will no longer provide such coverages in reasonable amounts and at a reasonable cost, lenders must reluctantly waive or modify that requirement. If, however, the borrower has begun to reserve against such losses in a separate, private insurance company, lenders generally view such borrowers more favorably than those without such a mechanism in place.

This concept is predicated on three important factors: First, the new company must be formed as a real insurance company, which means that it must assume actuarially definable risk. Second, the risks transferred must be carefully structured so the new insurance company has a good chance of generating an underwriting profit (even in the event of another hurricane). Finally, the insurance company must comply with the tax rules to be certain it captures the financial benefits.

Note that a private insurance company generally does not replace existing insurance; it supplements current coverages by focusing on those risks that the business does not or cannot purchase from the insurance industry. If that industry is forcing one to self-insure, why not gain some risk management, tax and financial benefits from that situation?

Owning a private insurance company requires careful risk management planning and compliance with complex insurance and tax laws, based on sound advice. The result for the real estate business, however, is an extraordinarily helpful risk management tool with significant upside potential for its owners.

James Landis (jlandis@intuitiveinsurance.net), JD, MBA, is managing partner of Intuitive Captive Solutions and is an author and national speaker on the subject of captive insurance companies. Rick Eldridge (reldridge@intuitiveinsurance.net) is the founder of Intuitive Insurance Corporation and has more than 20 years of experience in risk management and insurance P&L responsibility.

Article From Florida Real Estate Journal