The "Soft IRR" calculation for single parent captives
Financial benefits of tax savings, premium savings, etc.
There are many benefits to a company standing up a single parent captive including risk management & loss control, tailored coverage, insurance cost savings. However, this post dives into the financial engineering as I see it - specifically around savings & taxes.
In short, instead of paying large premium $$ to a third party insurance carrier, a captive allows you to pay that premium into an entity that you own, AND still deduct that premium from income for tax purposes. The below looks at the “soft IRR” of a captive insurance company by factoring in tax savings, premium saved, and investment income…
Let’s imagine a 7 year captive insurance program. The “max loss” we are insuring up to is $50mm, and therefore need to capitalize the captive for $50mm in year 1, and topping that number up to $50mm every year depending on claims & expenses.
Other assumptions to note (tagged accordingly in the screenshot):
This business does $10mm / year in earnings
7 year captive program
We are able to account 50% of the $50mm dollars in as “premium” (tax deductible) while 50% is contributed capital (not tax deductible). This is a very loose assumption
This reduces the tax bill to $11.25mm over 7 years (assuming 25% tax rate) vs. $17.5mm
Saved premium (otherwise paid to third party carriers) also factored in. This premium number is $25mm / 7 (# of years). This is also a very loose assumption
So, while the “hard dollar IRR” is -3.76% in terms of actual cash in and cash out (we’re assuming a few million in claims every year and relatively low investment income), you can tell a story of +6.5% “soft IRR” in the same scenario if you factor in saved premiums and tax benefits.
Soft IRR detailed calculation below (based on above math + assumptions)
Keep in mind, there are MANY ways to structure these programs and MANY assumptions at play here. However, hopefully this gives a sense of the tax and savings impact in a captive insurance program.