Randy Sadler, CIC Services
26 September 2022ArticleLaw & regulation

How captive insurance can offset risk and the impacts of litigation in economic downturns

Litigation is a costly endeavour for businesses and while it has never been cheap, costs associated with it have consistently risen over the past few decades. From the client’s perspective, there are a lot of unknowns and questions that must be asked such as high and low-cost estimates for fees over the coming month or months, and many other variables.

That doesn’t even begin to factor in the potential payouts a business may have to pay at the conclusion of the case if the organisation is found to be at some level responsible.

Something else to consider is a May report from LendingClub Bank, which showed that 64 percent of Americans live paycheque-to-paycheque in 2022. This is relevant because in instances of financial hardship, alternative means of finance, such as litigation-sourced financing, may be an attractive option for many consumers—this includes those unable to obtain traditional financing.

This is because one standard litigation-funding transaction is non-recourse. This means that if no financially valuable verdicts are rendered on the case, the consumer is not required to pay back the funder of the litigation.

What does that mean? In times of economic hardship people in financially unfavourable circumstances may be more inclined to go to the courts in an effort to receive financial gain. With the global and domestic economies currently encountering some levels of strain and instability due to geopolitical happenings as well as residual effects from COVID-19, now is a time where litigation could increase against businesses.

With captive insurance, however, business owners, especially those in heavily litigated industries such as the construction and medical fields, can insure their risks. This is because captive insurance utilises more comprehensive coverages and reduces the potential for serious financial and operational losses.

Significant expenses for companies big and small

A previous study from the US Chamber Institute for Legal Reform (ILR) found that liability costs for businesses increased 14 percent from 2016 to 2018. Small businesses faced the brunt of the impact of this type of litigation as businesses that made $1 million or less annually were held responsible for 39 percent of liability litigation-related costs.

Businesses with over $50 million were held at 37 percent responsible on average for liability litigation-related costs.

Most businesses are, however, more in line with a categorisation of being a small business, making it especially concerning when considering that in 2018 the total dollar amount in liability costs for small businesses was $343 billion.

The ILR’s study told an alarming tale of a small business owner, Chuck Jones of Jones Coffee Roasters, who sunk hundreds of thousands of dollars of his own money into a costly decade-long legal battle. Jones said that the significant legal expenses he and his business incurred over the course of the case was cash he and his family’s business couldn’t spend on hiring, expanding, or building new products.

From the larger scale end of things, look back at a lawsuit faced by McDonald’s in 1993 over a 79-year-old who sued McDonald’s over its coffee giving her third-degree burns after she had spilled it on herself. While found partly responsible for her own injuries, the plaintiff still received $3 million in punitive damages. McDonald’s, being the major corporation that it is, was financially fine after the settlement of the case. For an ordinary small business, however, that would mean financial ruin.

How captive insurance can help your business

Commercial insurance companies today are not able to react to the constant shifts and changes in the market and are unable to insure the many hidden risks businesses face in everyday general operations. For the businesses that are potentially affected by those risks unprotected by commercial insurance, this is where captive insurance comes in.

A captive, a wholly-owned subsidiary of the insured company, acts as a reservoir holding capital in case of a crisis. As the business’s risk management needs change, the captive can quickly provide coverage needed to facilitate the owner’s requirements. In the economic spaces of today and tomorrow, captive insurance can be the difference between making it through a possible crisis or shutting down because of it.

Additionally, captive insurance defers taxes on loss reserves, which allows for the accumulation of a larger pool of funds for investment. Incoming premiums that aren’t paid out in claims or in administrative costs further increase the size of the loss reserves, or it becomes an underwriting profit. Over time, captive insurance can grow into a profit centre.

Ultimately, the goal of captive insurance is to aid the business in managing its risks and mitigating any potential losses. The bottom line is that captive insurance can serve as an impactful financial vehicle that answers the questions chief executive and operating officers ask when trying to reduce business risks and maximise profits.

Randy Sadler is a principal with CIC Services. He can be contacted at: randy@cicservicesllc.com