Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / How Franchisees Use Insurance Captives to Cut Premiums
Transcript
- Lucas: You know that feeling when your insurance premium comes in and it's just... higher than the year before, again, and you don't really have a good reason why? Luna: Yeah, it's a pretty universal frustration. Especially for franchisees who feel like they're getting lumped in with the worst risks in the system. Lucas: Right. So a growing number of multi-unit franchisees are doing something about it. They're forming their own insurance companies. Legally, they're called captive insurers. Luna: And this isn't some hypothetical thing for big corporations. I've seen franchises with 20 or 30 units starting to explore it. Lucas: Exactly. In 2023, a group of 25 7-Eleven franchisees in Texas formed a group captive. They were tired of the commercial market jacking up their workers' comp rates. Within the first year, they cut their premiums by nearly 30 percent. Luna: Thirty percent is significant. But I imagine there's a big upfront cost, right? You can't just decide on a Tuesday and have a captive by Friday. Lucas: No, it's not a quick fix. Typically you need anywhere from $250,000 to $500,000 in capital to even get started. And that's before you pay the actuaries, the lawyers, the third-party administrators. Luna: So who's actually doing this? Is it mostly the big quick-service restaurant guys, or are we seeing smaller franchisees too? Lucas: The sweet spot seems to be franchisees with at least 30 units. And it's not just QSR. I've seen it in auto repair, fitness, even some retail franchises. The common thread is that they have predictable, relatively low-severity claims. Think slip and falls, minor property damage — not catastrophic liability. Luna: That makes sense. If you've got a lot of claims that are small and frequent, you can model that pretty well. But if you're a franchise that could get hit with a huge lawsuit... maybe not. Lucas: Right. And that brings us to the three main captive models. The first is the single-parent captive — that's one company, usually a very large franchise group, creating their own insurer. Then there's the group captive — which is what the 7-Eleven franchisees did — where multiple unrelated businesses pool their risks. And then there's the cell captive, which is like a shared structure where each franchisee has their own segregated cell. Luna: So which one is most common for franchisees? Lucas: Group captives, by far. Because it spreads the administrative cost and the capital requirement. A group captive might need each member to put in $50,000 to $100,000, rather than a half million on your own. Luna: But here's the thing I always wonder about: when you start your own insurance company, you're on the hook for claims. What happens if one member has a terrible year and blows through the reserves? Lucas: That's the single biggest risk. In a group captive, you typically have a provision called 'several but not joint' liability — meaning you're only on the hook for your own share of losses. But if the whole group under-reserves, everybody gets a capital call. And that's exactly what happened to a fitness franchise group in Florida. Luna: I remember hearing about that. They had to put in an extra 40 percent on top of their original premium. Lucas: Yeah, it was a mess. They had a few locations with high injury rates from personal training incidents, and their actuary had underestimated the loss development. The captive was just two years old, and suddenly they needed an extra $300,000 from each member. Luna: So the actuarial piece is crucial. You can't just guess. Lucas: Absolutely. And that's where you need a good captive manager. But if you do it right, the benefits go beyond just lower premiums. You also get control over claims handling, you can earn investment income on the reserves, and there are potential tax advantages. Luna: Let's talk about the tax piece. Because I know the IRS looks at captives closely. They don't want you setting up a captive just to dump money in tax-free. Lucas: Right. Under IRS rules, a captive needs to be a legitimate insurance company. That means it has to have risk distribution and risk shifting. In practice, the captive needs at least 12 unrelated policyholders to meet the risk distribution test — unless you use a cell captive structure. And the premiums have to be arm's-length, not just a tax dodge. Luna: So if you're a franchisee with 50 units, you could form a single-parent captive, but you'd need to have those 50 units all contribute separately, and you'd need to demonstrate that the risk is spread across different locations. Lucas: Exactly. And there's also the 831 election, which allows small captives — those with under $2.3 million in premiums — to elect to be taxed only on investment income, not on underwriting profit. That's a huge benefit, but the IRS has been auditing these aggressively. Luna: So we've got the upside: 15 to 25 percent premium savings, more control, potential tax benefits. And the downside: capital requirements, actuarial risk, regulatory compliance, and the possibility of a capital call. Lucas: Right. And let's not forget that captives are regulated at the state level, so you need to pick a domicile. Some popular ones are Vermont, the Cayman Islands, and South Carolina. The regulatory burden is real — you have to file annual statements, get audited, maintain solvency. Luna: But if you're a multi-unit franchisee with a clean claims history and a long-term outlook, this seems like a no-brainer if you can get the scale. Lucas: I'd say it's worth investigating. The first step is to get a feasibility study done by a captive consultant. They'll look at your loss runs, your premium history, your unit count. If the numbers show that your loss ratio is consistently below 60 percent, you're probably a good candidate. Luna: And that study might cost you $10,000 or $15,000, but it pays for itself if you find out you can save 20 percent on premiums. Lucas: Exactly. And if you don't have enough units yourself, you can band together with other franchisees in your system. Some franchisors are even starting to help facilitate these group captives because they know it makes their franchisees more profitable. Luna: Speaking of profitability — if these conversations have moved your work forward in some small way, there's a simple way to keep them going. listener support is what keeps this show ad-free and independent. Lucas: Yeah, it's true. No sponsors, no corporate overlords. Just two people trying to figure out how franchises actually work. If that's worth a coffee to you, you can find us at buy me a coffee dot com slash fexingo. Luna: And we don't sell data or run ads, so your support genuinely matters. Thanks for being part of this. Lucas: So back to captives — one more thing I think is worth mentioning: the timing. If you're thinking about a captive, start the process at least six months before your current policy renews. It takes time to get the feasibility study done, form the entity, and get the regulatory approval. Luna: And don't forget to budget for the premium when you're in the captive — because you still have to pay premiums into your own company. It's not free. Lucas: Right. But over time, if claims are good, those premiums come back to you as profit. Some mature captives have returned 50 percent of premiums to members after five years. Luna: That's a powerful incentive. Especially for franchisees who are tired of writing a check every year and getting nothing back. Lucas: Exactly. So the takeaway: if you've got scale, clean loss history, and a long horizon, a captive might be the most effective cost-saving tool you haven't tried yet.