Captive Auto Finance
Captive insurance companies provide a profitable and powerful tool with which to manage the risks for a business. Dealerships routinely form their own captive auto finance policies to gain greater control over their risks. This article explores how captive insurance companies can provide a desirable return on their investment for a dealer.
First off, let’s discuss what kinds of risks a dealer can insure. Captive auto finance can provide customized insurance for coverages you might not be able to find on the market, or at least not be able to find at a reasonable premium. A few lines of coverage a dealer may consider putting into a captive include:
- Directors & Officers Insurance
- Indirect Business Interruption Insurance
- Warranty Insurance
- Legal Defense
- Professional Liability Insurance
- Repossession Costs
- General Liability
These insurable risks are common to virtually every dealer and create unique opportunities. For example, paying insurance premium for a warranty into a captive provides insurance for dealership’s automobile warranties in the event of a claim. The premiums paid for warranty insurance through the captive are all deductible as a business expense from the dealership. With smart underwriting, the warranty service can end up producing a profit for the captive insurance company and transform the company’s cost center into a profit center.
Many risks are not good risks for a captive. Poor loss history means that the insurance company is getting called too often. Those kinds of risks are not well suited for a captive as they may end up draining the captive of its reserves. The important rule to remember is that a dealer may choose which risks to place in the captive a la carte and maintain traditional commercial insurance for specific risks. In this way the dealer creates an optimized risk management policy.
What about PORCs?
You may have heard of dealers using captives with regard to a reinsurance arrangement. Producer owned reinsurance companies (“PORCs”) allow dealers to share in the underwriting profit and investment income on the extended service contracts and other insurance products sold by the dealer.
The IRS took an interest in PORCs for years because they were abused as tax shelters. The arrangement catching the IRS’s attention was the use of vehicle service contracts where a customer remitted insurance premium to a third party insurer (the “direct writer” licensed to sell insurance) while the dealership retained a portion of the income as “reinsurance” to the direct writer. The reinsurance premiums held by the PORC earned investment income and were distributed to the dealers at tax advantageous rates.
PORCs were scrutinized by the IRS for several years shortly after the turn of the 21st century. Although case law took several years to develop, PORCs are legitimate insurance arrangements provided that the insurance company: (1) satisfies a business need; (2) does not inappropriately shelter income; and (3) do not function as a private bank account for the dealer. See TAM 2004-53012; TAM 2004-53013.
Whether captive auto finance is a good fit for your dealership comes down to your appetite for risk management. You can achieve the greatest control over your business’s risk profile through the use of captive insurance. In addition, smart structuring and underwriting can turn insurance into a profitable venture for your dealership.