Micro-Captive Insurance: an Option for Smaller Manufacturers
Persistent inflation globally, coupled with a rise in natural disasters, continued disruptions in global operations and shifting political conflicts have exacerbated the challenges facing manufacturing businesses here in the U.S.
As many manufacturers discovered during COVID-19 shutdowns, mainstream insurance plans did not cover losses or damages. Though some government grants and relief programs became available, it was not enough for some businesses.
Relief for Small Businesses
Nearly 40 years ago, the U.S. Congress passed the Tax Reform Act of 1986, which included Section 831 of the Internal Revenue Code. This code created a self-insurance option for small businesses, often referred to as a micro-captive insurance plan. These plans allow small businesses to set aside tax-deferred dollars for unforeseen risks that are unique to their industry and typically not covered by mainstream insurers.
This bipartisan piece of legislation was due, in part, to the hardening insurance market and limited options available at the time. Traditional insurance company limitations are still a significant issue affecting small businesses today, as carriers begin to leave states entirely and increase rates.
Captive Arrangements
Similar to captive insurance plans that have been available to Fortune 500 companies for decades, micro-captive insurance plans are essentially small insurance companies wholly owned and controlled by their insureds.
A company can establish a micro-captive on its own, or hire a professional captive administrator or management firm to help navigate regulatory requirements and documentation. Other captive arrangements can also be an option for some companies, including group captives and cell captives.
Micro-captives are smaller than traditional captives, providing a $2.85 million annual premium deposit cap adjusted annually for inflation. This coverage option can be not only cheaper than traditional insurance options, but also allow greater flexibility and coverage options for manufacturers to protect against niche disasters that plague the industry.
Added Protections
In addition to other losses, micro-captive policies can be tailored to protect a business from supply chain disruptions or product recalls.
For instance, a micro-captive insurance company had a client in the automotive industry who utilized the Supply Chain Interruption Policy established in their plan. The supplier’s failure to produce an RV wiper seal in line with the manufacturer’s specified order requirements caused the product to miss its scheduled container shipment from the origin country. This disruption led to significant consequences, including several months of lost sales, increased shipping-related expenses and a higher cost per foot for the two seals in the order.
When the unforeseen event occurred, the company leveraged its micro-captive policy to recover the increased costs and alleviate financial strain. This proactive measure allowed the business to continue operations without incurring additional debt or depending on traditional insurance, which likely would not have covered such specific losses.
831(b) micro-captive insurance plans allow manufacturing companies greater control and specificity over policy limits and coverages and open the potential for lower premiums long-term. However, this additional control brings with it some potential downsides that manufacturers should remain aware of. Like any form of self-insurance, captives involve bringing some risks in-house. This is why many firms use captives to supplement broader commercial policies, or for coverages they can’t find on the commercial market. A micro-captive may also bring some legal risks due to scrutiny from state and federal government agencies.
Despite being a lesser-utilized Section of the Tax Code, 831(b) has had major impacts and benefits for companies opting to implement it in years past. Through research and proper implementation with a qualified micro-captive manager, these programs have the potential to reshape the way America’s manufacturing industry operates and survives increasingly turbulent global challenges.
