By Peter Strauss

Life is filled with risk. Every day, you take risks in your business. Some of these risks are calculated—after all, you must take on some risk in order to make a profit in your business. Other risks may not be so well known to you or may not usually be at the forefront of your mind. For example, you may carry insurance on the truck used to make deliveries in your business, but you may not think to—or can’t afford to—carry similar insurance on the computer used to track your deliveries or inventory.  You live with the risk.

Smart business owners engage in this type of self-insurance almost every day in their businesses, unable to obtain certain forms of coverage because they are too expensive or unavailable on the commercial market.

According to the American Institute of Certified Public Accountants (AICPA), most businesses self-insure a great part of their risks from daily business activities.

The solution, states this AICPA report, is captive insurance. Captive insurance is a strategy whereby your business purchases insurance coverage from an insurance company that you own and control, i.e., a “captive” insurance company.

The design of the captive insurance plan is pretty simple:

• An operating business forms its own insurance company, paying premiums into it
• the insurance company provides insurance to the operating business
• the insurance company acquires reinsurance coverage to protect against catastrophic claims
• the insurance company processes its own claims and pays out of its own pocket for smaller claims, using reinsurance to handle bigger claims

That’s it. That is all you need to know. Sounds simple, doesn’t it? Of course, everything is in the details, but understand this point: captive insurance is a simple concept. Just as you know how to run your business even if you don’t understand how to run every machine in your factory, if you keep these four design points in mind you will know how to examine a captive insurance structure—even if you are not ready to start writing your own policy forms and processing your own claims.

Here’s the kicker: the premiums paid by your business are tax deductible and the premiums that your captive collects are tax-free.

You read that correctly: The premiums collected by your captive insurance company are tax-free.

Suppose your business pays US$1 million in premiums to your captive insurance company every year. Assume further that your combined federal and state income tax rate is 50 percent. Your business would deduct US$1 million from its taxable income, saving you US$500,000 each year. Furthermore, that US$1 million would be received free of income tax each year inside your captive insurance company. You would pay less in taxes, have a more robust risk management tool, and have more money in the bank.

You may be thinking that setting up and running a captive insurance company requires you to hire lots of experts, attorneys, and accountants.

Fortunately, there are many service providers in the captive insurance industry. The industry has significantly matured over the past 60 years such that many service providers offer “turnkey” service packages in which the most critical functions of your captive insurance company are handled for you.

Most service providers will offer the following services as part of a turnkey package:

• analyzing your business and its insurance needs
• establishing and licensing your captive insurance company
• arranging reinsurance for your captive

Captive insurance helps businesses address the problem of inadequate insurance that traditionally has been unavailable or too expensive on the commercial market. Furthermore, captive insurance produces material tax savings that help you to save real dollars in your business. It is one of the most valuable, well-kept secrets of the insurance industry for American businesses in the past 70 years.

The secret’s out.

Peter Strauss is the managing member of the Strauss Law Firm, a multidisciplinary law firm based in Hilton Head Island, South Carolina, and author of The Business Owner’s Guide to Captive Insurance Companies (Forbesbooks).