In conjunction with the great people at TaxConnections, we’ve published a new eBook on captive insurance titled “Who Should Form a Captive Insurance Company?”. You can buy a copy HERE. Cost: $4.98.

One of the most frequent questions people ask about captives is simple: am I a candidate? There are several ways to answer this question. The first is to simply look at a company’s financials. Captives begin to become a viable proposition when gross revenue is at least $1 million. Another way to look at this is from a free cash flow perspective. I define free cash flow as net income plus depreciation. If this number has been at least $250,000 for the last few years, the company has adequate cash flow to consider forming a captive.

A second way to answer this question is this: do I have risk that is uncovered by my present policies? If you ask most entrepreneurs “what risks keeps you up at night” chances are they have 3-5 scenarios that, should they happen, will greatly threaten their business. For example, if they own a manufacturing company, the possibility of both product recall and product liability loom large on the horizon. Some companies derive a large percentage of their revenue from a single client or have a single source provide most of their raw materials. In captive vernacular, these are “key clients” or “key suppliers.” The loss of either is an insurable risk. Licensed professionals face the possibility of loss or suspension of their license. And most businesses need some type of coverage legal defense.

And finally, there are some industries that are more likely to form a captive, usually because they are simply riskier than others. Here, doctors are the quintessential example. But also consider a trucking company – a space that is currently experiencing increasing insurance costs. Manufacturers were previously mentioned, as they are exposed to potentially devastating lawsuits should their product be deemed “defective.” Commercial real estate companies that own buildings along the coasts face very high deductibles for flood damage. Companies that are based on intellectual property need coverage in the event they have to defend their business against non-authorized use of their IP. And considering the ubiquitous nature of the internet, most companies need some type of coverage for cyber liability – especially those that specialize in internet commerce.

So, there are really a few ways to answer this question, “should my company form a captive.” First of all, small companies (less than $1 million in gross revenue) are simply too small. Second, some companies face certain “nightmare” scenarios such as loss of a key client of product liability, most of which can be insured by a captive. Third, some industries like the medical field or trucking are simply riskier than other businesses.

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