Add dollars to a deal with the right captive insurance structure

From a high level, captive insurance programs offer companies flexibility to manage their unique risks.

Captives can also bring value to companies, and wealth to owners and stakeholders, but too often these opportunities aren’t recognized.

“Owners of a captive insurance program have access to the earned revenue that exists in the program,” says Andrew Seger, general counsel at Imprise Financial. “That money can be added back into the value of the company at the time of a sale or extracted when the owner exits. But the potential value that captives could contribute is commonly overlooked.”

Smart Business spoke with Seger about the ways captive insurance programs can be structured and how that affects company value.

What are the factors that determine how a captive insurance program is structured?
A captive insurance program’s structure is contingent on the needs of the business and the goals of ownership. Generally, structuring a captive as a subsidiary of a company places ownership of the captive with the operating company. Structuring as an affiliate puts ownership with the person or persons who own the company. In both instances, it’s a separate legal entity.

Owners who want to make sure the assets of the captive are going to be reported on the operating entity’s balance sheet should structure it as a subsidiary. In a situation in which only some of the shareholders are entitled to the profits of the captive, it’s best to structure it as an affiliate.

How does the structure of a captive program affect whether it is sold as part of the company?
Whether or not to include the captive in a sale is up to the buyers and sellers. Often it hinges on how important the captive is to operating the business. If it’s an entire franchise that’s being sold and all franchisees have insurance from the captive, that’s part of the value proposition and the acquiring company will want that program as part of the deal.

Other times, the buyer is not interested in the captive or it is not essential to business operations, which leaves the assets of the captive with the exiting owners to be extracted. In situations in which the captive is set up as an affiliate and more for long-term wealth building for the business owner, it’s not usually part of the deal.

How do buyers calculate a captive program’s value when it’s a part of the sale of a business?
When a captive is structured as a subsidiary of a company and the company is sold, bankers and private equity firms tend to add back to revenue the cost of its insurance premiums because it’s a risk management vehicle and not an expense — it’s not decreasing the revenue number that someone valuing a business would look at.

With the help of a captive manager, the purchaser will also project the future performance and profitability of the captive and work that into the value of the business. If the assumption is that the operating business is going to grow, the captive grows with it. It comes down to determining what the metrics will look like and how that affects EBITDA.

Valuing the unearned premium — money that’s tied to existing claims or policies and can’t be extracted — is accounted for differently. If there’s a lot of it, then there will be a larger risk of future claims. In that case, the captive manager will conduct an actuarial review of the projected future losses to help the parties agree upon a future valuation of the captive involved in the transaction.

That could also take into account the history of the captive’s operations and what the actuaries predict could happen while the premium is still unearned.

As with any business, there’s no perfect science to determining the value of a captive in a transaction, but the key is to get everyone involved to understand the captive’s operations and come to an agreement. That’s why having an experienced captive manager involved from the start of a program is critical.

They know how to get the most out of a captive based on the owners’ long- and short-term goals. Companies that don’t discuss their plans with a captive manager will have fewer options when major events, such as an exit or capital investment, occur.

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