Turning An Accounting Reserve Into A Captive Insurer

Hale Stewart

“A reserve is an appropriation of profits for a specific purpose. The most common reserve is a capital reserve, where funds are set aside to purchase fixed assets. By setting aside a reserve, the board of directors is segregating funds from the general operating usage of a company.”

For example, suppose a company installs a product and, as part of their service contract, guarantee their work for a specific amount of time. In order to pay for this work, the company’s accountant sets aside a specific amount of money in a “reserve” account to indicate the potential cost of this service. Over a number of years, the size of the reserve increases as the company sells more of its service.

In effect, a reserve is nothing more than a company saying, “we potentially have to spend $X amount of dollars on this item.” But the reserve is an accounting liability; the larger it grows, the more it can negatively impact the company’s net worth and, by extension, the company’s ability to get and maintain credit.

A far better option is for the company to reclassify the reserve as an expense, usually by converting it into a warranty program. This allows the company to remove the liability from its balance sheet and place it into a captive insurer. This also turns a segregated liability into an expense, which is far more efficient.

In reality, if your company is using a reserve for a liability, it’s already more than halfway to forming a captive insurer.

Mr. Stewart has a masters in both domestic (US) and international taxation from the Thomas Jefferson School of Law where he graduated magna cum laude. Is currently working on his doctoral dissertation. He has written a book titled US Captive Insurance Law, which is the leading text in this area.

He forms and manages captive insurance companies and helps clients in international tax matters, US entity structuring, estate planning and asset protection.

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1 comment on “Turning An Accounting Reserve Into A Captive Insurer”

  • Rajendra Singh

    Mr. Stewart.

    I enjoyed your webinar yesterday. You will make one of the best-liked teachers on any campus. I bought your book.

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