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.

To help potential captive owners determine if they should form a captive, I’ve written the “10 questions,” one of which is:

“Do my current insurance policies cover ALL my risks?”

To explain this concept, you need to understand a little bit of insurance coverage history. In the 1970s, the insurance industry was sued under four broad causes of action: negligence, asbestos liability, environmental liability and professional liability (especially medical malpractice). This period was the height of the plaintiff’s bar; multi-million dollar awards were common place, eventually leading to the bankruptcy of some smaller insurance companies. Larger insurance companies also took major hits.

As a result, all insurance companies started to greatly reduce the number and dollar amount of risks they covered. Most of the excluded risks were “stochastic” in nature; these are risks that occur less regularly, but, when they do occur, would have higher payouts. Captives now cover these risks. Here are some examples of “standard” captive coverages:

Business Interruption: This policy will cover losses related to loss of income for a variety of reasons, including natural disasters, loss of power and national emergency.

Collection Risks: The policy will cover losses from overdue debts or lost revenue from services performed on behalf of clients or pending clients. Expenses directly related to the collection of overdue debts or lost revenue are included. It also covers losses arising from clawbacks or returns caused by identity theft and other errors or omissions of the insured.

Communicable Disease Liability: The policy will reimburse the insured for losses and expenses incurred from protecting the insured’s business, employees (and their immediate families) and clients from exposure to epidemic diseases, such as HIV/AIDS.

Contractual Liability: The policy will reimburse the insured for losses and expenses incurred from torts committed by the insured or by a third party (e.g., insured signed a hold harmless agreement with a third party). Coverage for breach of contract and wrongful acts are provided.

Cyber Liability: The policy will cover losses from first and third party risks associated with networks, ecommerce, the internet and other computer or electronic media. Coverage is provided for breach of privacy and other similar data breaches, infringement of intellectual property and computer virus transmission that may be passed from first parties to third parties via a computer. Coverage for network extortion threats are also included.

Employment Practices Liability/EPL Difference in Conditions: The policy will cover claims made by employees, former employees or potential employees against the employer for discrimination, wrongful termination of employment, sexual harassment and other employment-related allegations.

General Liability Difference In Conditions: The policy will cover losses for a wide range of coverages that are normally excluded in standard general liability policies. Some of these exclusions are: (i) intentional injury liability, (ii) liquor liability, (iii) pollution liability, (iv) wrong description of services or goods, (v) copyright, patent and intellectual liability and (vi) identity theft liability.

Hourly Wage Violations: The policy will cover losses from hourly wage violation exposure including losses arising from class action lawsuits.

Legal Expense: Although the insured purchases various insurance policies, the course of normal business activities expose all business owners to unanticipated legal expenses including frivolous legal actions for which existing insurance coverage is either limited or excluded. Legal actions limited or excluded by other policies will be covered by this policy.

Loss of License: The policy would cover the expense for actions involving the suspension or revocation of professional licenses and other business licenses including licenses issued by the local health department or municipality.

Regulatory Change: This policy covers the risk that a change in laws and regulation will significantly impact an industry. A change in laws or regulations enacted by a governmental or regulatory body can dramatically increase the costs of conducting business, decrease the attractiveness of an investment, or change the competitive landscape.

Reputational Risk: The profitability of the business is closely tied to the positive reputation of the business conveyed to the public. Should the insured’s reputation be damaged, the insured would likely suffer a reduction in business revenue and would incur additional expenses to reclaim a premier reputation. The policy would reimburse the insured for both loss of business revenue and expenses incurred related to reputational risks.

There are really only a few limits on the policies a captive can underwrite. Legal viability and actuarial verification. Legally, the insured must be able to demonstrate the policy is insurance rather than say a financial instrument like an options or futures contract. From an actuarial perspective, the premiums charged must make sense – that is, an actuary has to demonstrate the underlying rationale for the proposed charges. But once these elements are established, you’re good to go.

In accordance with Circular 230 Disclosure