July 7, 2025 • 41 mins
Most real estate investors think insurance is just a cost of doing business. They're wrong.
Insurance is the ultimate wealth transfer mechanism—and most of us are on the losing side.
In this episode, I sit down with Tony DeFede from Union Risk to uncover how captive insurance programs work, why Warren Buffett has used them for decades, and how real estate investors can flip the script from paying premiums to collecting them.
What You'll Learn:
- Why insurance premiums have exploded 2-3x (and who's profiting)
- How captive insurance creates a new asset class you actually own
- The tax advantages that can save you hundreds of thousands annually
- Why the minimum $250K premium requirement might be worth it
- How to participate in the wealth transfer instead of funding it
Key Insights:
- The Lloyd's of London model that's been working for 337 years
- How Berkshire Hathaway turns your premiums into their investment profits
- Why the current hard insurance market is creating massive opportunities
- The real reason major carriers are "exiting" markets (spoiler: they're not losing money)
This isn't about saving money on insurance. It's about understanding how the wealthiest families have been quietly building empires through risk management for centuries.
For serious real estate investors and business owners who want to stop funding other people's wealth and start building their own systems of control.
The Timeless Investor Show explores the principles of building, preserving, and passing down real wealth across generations. Hosted by Arie van Gemeren, founder of Lombard Equities Group.
This episode pairs perfectly with our historical series on wealth transfer mechanisms. History doesn't repeat, but it rhymes—and the patterns are all there if you know where to look.
Subscribe to the Timeless Investor Newsletter for our long-form content.
Follow the Timeless Investor Show if you want to hear more of our podcast content.
Get your own copy of Timeless Wealth: Real Estate Through the Ages.
If you want to learn about new investment opportunities through Lombard Equities Group (accredited investors only), please reach out here.
Think Well. Act Wisely. Build Something Timeless.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
SPEAKER_00 (00:00):
Hello, everybody.
Welcome to another episode ofthe Timeless Investor Show
Premium for our paid subscribersto the Timeless Investor
Newsletter.
I'm incredibly excited to behere.
This is just full disclosure foreveryone.
This is my first actualinterview with someone.
We obviously run a podcast showand I do a lot of solo episodes.
(00:21):
So Tony here is going to be ourtest subject.
And brought directly to you guysto hear some incredible intel
and really exciting stuff that Ijust learned yesterday.
Tony is a subscriber to theTimeless Investor Show.
So we are building a really coolcommunity here.
He actually reached out to meand was interested in what we
(00:41):
were doing.
And we had this incredibleconversation, which...
Literally, we talked yesterdayand I was like, I've got to get
this going ASAP for everyone.
This is incredible intel, reallyvaluable insights, something
I've been thinking about a lot.
So I want to introduce you guysto Tony DeFede with Union Risk.
His firm specializes in settingup captive insurance programs
(01:03):
for operators of real estate andany other business all across
the country.
This is a strategy that...
The big boys have been using fora long time to control insurance
costs and premiums.
And Tony's team makes itavailable for everybody, right?
I mean, you still have to have afairly large portfolio and quite
(01:24):
a bit of stuff.
But just quickly before I letTony take off, I just wanted to
set the framework here.
So most of you are real estateinvestors or business owners and
everyone is sort of dealing witha really brutal situation.
insurance premium environment.
And we've talked about it.
We wrote pieces on the hardcycle of insurance over time.
And the insurance industry isthis incredibly cyclical beast,
(01:47):
right?
And we're in a hard cycle rightnow.
And I'm really looking forwardto hearing Tony's analyses of
kind of what's going on.
But for ourselves, we've seeninsurance premiums go up 2X, 3X.
All the major carriers areexiting.
American Family was a hugeinsurance company we worked with
all across the PacificNorthwest, and they completely
dumped multifamily risk, andit's caused premiums to rise
(02:10):
everywhere.
State Farm is exitingCalifornia.
It's a really bearish time forinsurance, and this is the time,
and this is why I'm reallyexcited about this, and we're
going to try to do this with theLombard Equities portfolio and
other partners we have in thismarket.
This is the time for creative,unique solutions, and Tony has
got it.
So, Tony...
Please introduce yourself andtell us your analyses of the
(02:33):
insurance market, and then let'sdive into captives.
SPEAKER_01 (02:36):
Sure.
All right.
Well, thank you for having me.
I am Tony DeFede, the partnerand the chief risk officer at
Union Risk Services.
Union Risk is a captiveinsurance specialty brokerage
located in New Jersey,specializing in captive
insurance for companies doingbetween$5 million a year in
revenue and close to a billion ayear in revenue and everywhere.
(03:00):
in between.
With where the insurance marketis right now, as I'm sure
everyone listening knows this,we are in the hardest insurance
market from what I have seen andfrom what I've heard from
industry veterans and Mohegansin the last 50 to 100 years
without a doubt.
These last five years ininsurance have been the toughest
(03:23):
time for the insurance industry.
And what does that mean?
That means for the payers ofinsurance, which are people like
Ari and the people listening tothis podcast right now, rates
are doubling, tripling,quadrupling in some cases.
Now, why is this happening?
Catastrophes have one thing todo with that.
(03:43):
Over the last five to sevenyears, over$50 billion in
catastrophe costs costs havebeen paid out by insurance
companies or are set to be paidout by insurance companies,
which they have to prepare for.
So that's one reason why nomatter if you have a car for car
insurance or homeowner'sinsurance, or if you're like Ari
(04:05):
and own a ton of real estate andmany doors, your insurance costs
are going up no matter what,because the insurance companies
themselves are in a position nowwhere they have to fund for
these massive claims which haveoccurred in the past five to
seven years.
And they are trying to makemoney on top of that.
And the only way to do that isto set the insurance increases
(04:26):
that we've been seeing for thelongest time.
Prior to the hard market wasprobably the best insurance
market in history.
And what leads to a greatinsurance market?
It's a few things.
The level of catastrophes were alittle less.
And all you need is a littlearbitrage there for insurance
companies to make the money theyneed to make from the investment
(04:47):
income, which is something weutilize with captive insurance.
The investment income for theseinsurance companies is how they
make all their money.
Even if their loss ratios are100%, meaning any premium that's
been paid in for a policy getspaid back out for expenses, they
are still making money on thatinsurance premium as it sits
there, which is what we do withcaptive insurance.
(05:10):
So when you have a soft marketlike we had, the liquidity was
plenty, the losses were a littlemore contained Right.
(05:40):
Certain premium numbers.
SPEAKER_00 (05:41):
And the timing, it's interesting too, like the timing
of the soft cycle and insurancereally coincided with incredibly
low interest rates as well,which is sort of, which we talk
about, you know, real estateisn't a bear market today.
And one of the factors that'scrushing real estate is interest
rates, right?
Interest rates have doubled ortripled in many cases.
And a lot of poorly underwrittendeals are really underperforming
(06:03):
now.
But the thing that I, I mean, wetalk about interest rate cycles
a lot.
in real estate because it'sincredibly critical to the
valuation of real estate.
But the input costs into runningproperties have risen
dramatically.
Payroll is up, right?
I mean, all driven by inflation.
But the thing that is reallytorpedoing a lot of deals is
(06:24):
that we...
So like on top of an interestrate increase, we've also have
this environment where premiumsare up two to three X.
And no one...
When you underwrite a realestate deal, it's like, you just
estimate 3%, 4%, 2%, somethingin that range, annual expense
increases.
I don't think anybody, anybodyin the entire real estate
business forecast 30% to 40%annual increases on insurance
(06:47):
premium, which is kind of whatwe're seeing.
Unless you have the highestquality asset that is brand new,
everybody else is gettingcrushed, which happens to be
most of the market.
One of the things I realizedwhen researching this more is
the It seems like one of thefactors that's really crushing
premiums is the reinsurancemarket has been really heavily
(07:08):
hit.
So reinsurers, from myunderstanding, are sort of
pulling back from underwritingrisk.
And that is also causing adownstream effect, right?
Because these insurance...
And I think for edification ofthe audience too, how does that
work?
The mainline carriers offset therisk to reinsurance, but if
reinsurance starts pullingout...
I think Swiss Re was sayingthey've had some massive amount
(07:31):
of claims and losses due tonatural catastrophes.
Also, the social unrest duringCOVID, like big buildings
burning down or being severelydamaged.
What effect have you seen?
I mean, that is obviously a hugeimpact.
Is that something you're seeing?
SPEAKER_01 (07:46):
Without a doubt.
Just for everyone who'slistening right now, reinsurance
is insurance for an insurancecompany.
So when an insurance carrier isgoing to write specific classes
of business, in this case, let'ssay real estate for Ari's
listeners, they are actuallygetting a sign-off approval from
their reinsurance company.
(08:07):
But what's been happeningbecause of these massive claims
we've been seeing for the lastfive to seven years, the
reinsurance companies have hadto pay claims or take on parts
of claims for their insurancecompany clients.
So when this happens now, areinsurance company sits back
after year end of 2024 and sees,oh, we are actually at a minus
(08:30):
of 15% across our reinsuranceportfolio.
So we're actually losing moneyon insuring our insurance
companies.
How do we stop this?
One way to do that is to raisethe reinsurance costs on
insurance companies, which inturn gets put onto the consumer.
In this case- RE and Lombardequities.
(08:51):
And another way they do this isby tightening their risk
appetite.
When you have insurancecompanies that have tightened
their risk appetite like theyhave for the last five to seven
years, there are just not asmany players in the marketplace
as there were in 2015, 2016,2017.
So all of this is the perfectstorm for the hardest insurance
(09:13):
market in history.
SPEAKER_00 (09:15):
Yeah.
Well, that's a critical piece.
And I feel like a lot of folksdon't fully understand or
respect the impact ofreinsurance on insurance, right?
Because insurance companiesaren't taking all the risk, like
you said.
And their ability to offer theirpremiums is because they offset
some risk.
And if that risk offsetting getspricey, that flows down to us.
(09:35):
The other thing, I'm kind ofcurious your perspective on
this.
Obviously, natural disastershave been rising.
um you know the the 10-year100-year storm is now like in
every other year occurrenceright florida hurricanes are a
really good example we've had adramatic increase in really
adverse weather eventscalifornia with the wildfires i
would argue it's also a climatechange related difference right
(09:59):
i mean i like i look at it fromthe pacific northwest i live in
oregon oregon's temperaturebands have risen over the last
10 years oregon is actually Iwould say a net beneficiary of
climate change because theweather has been getting warmer
and nicer.
It's almost like the newCalifornia.
And I'm from California.
When I go back to California,it's hotter, right?
It's hotter and it's drier.
(10:20):
And it's like that.
So the question that I wonder iswhen big weather events happen
in Florida or California, or youhave a Texas like major freeze,
right?
Texas is another market whereinsurance is really, really
difficult.
That has a knock on Ram.
So like, A lot of folks will belike, well, I invest in X market
(10:40):
where we don't haveweather-related events and other
problems.
But they're the same risk poolsthat are covering Florida as are
covering...
I don't know.
I can't think of a non-riskymarket.
But somewhere in the Midwestwhere they don't have tornadoes
and there's no bigweather-related problems.
But their premiums, I presume,are also rising because those
(11:01):
insurance companies are tryingto offset their risk in Florida
and California and othermarkets.
I mean, is that accurate tosay...
Natural weather patterns inparts of the globe that have no
impact on your market still havean impact on your premiums
because they have to offset thecost, right?
SPEAKER_01 (11:17):
Right.
That's exactly what's happeningis you have State Farm in
California, let's say, who justgot blown out of the water
because of the wildfires andother natural disasters.
Now we have State Farm in NewYork, who is all of a sudden
non-renewing auto liability riskfor transportation companies
because that risk is in New Yorkcoupled with the risk in
(11:39):
California is just not worth theoverall risk to a company like
State Farm.
So what happens now?
A major insurance player likeState Farm pulls out of New York
for transportation companies.
Now all of a sudden,transportation companies in New
York, instead of there beingfour major players, there might
only be three or two.
What happens then?
Because they've also taken onlosses, premiums just continue
(12:03):
to rise across the board.
So there is a correlation evenwith different insurance
companies, with their offeringsbeing affected by other carriers
SPEAKER_00 (12:13):
as well.
Right.
Well, it's going to beinteresting too.
For those of the listeners thatare investors in California or
homeowners in California, one ofthe things I've been watching
pretty closely is California–has been very successful at
artificially suppressinginsurance premiums in their
market.
And that is the reason most ofthese carriers are exiting
(12:34):
California because they're notallowed to raise premiums the
level they want to raisepremiums.
And for example, my home inPortland, I pay about$1,000 a
year for my homeowner'sinsurance.
And I have many, obviously fromthe Bay Area, many friends who
pay$6,000 to$7,000 a year rightnow for their homeowner's
premium.
And that is a suppressedpremium.
rate in california because thecalifornia insurance commission
(12:55):
won't allow them to raise ratesso this is giant game of chicken
what's this is a total tangentbut what's really alarming about
that if you're a californian orany other market that has an
artificially suppressed premiumenvironment is eventually
california i mean californiacan't play that game forever
they need to have insurers andcalifornia can't underwrite all
(13:15):
the risks themselves What Ithink will happen is they'll
have to capitulate.
And then if they let premiumsfloat to the level they actually
have to be in market, it's goingto be a double or tripling of
homeowners insurance premiums,which has a serious knock-on
effect.
If you think about your abilityto afford a home in California,
(13:37):
if the premium triples forhomeowners insurance, what does
that do to home values inCalifornia?
And actually, it's even moreIt's even more nefarious because
California's Prop 13 controlsproperty tax rates, right?
But you reset your property taxrate based on the purchase price
of the home.
So California is in a really bigpickle right now because if they
(13:57):
let premiums float, home pricestank and their property tax
revenue will start to drop.
People will be reassessingproperty tax rates, all this
kind of stuff.
So it's a really diceysituation, you know, driven by
some government policyinvolvement in the business,
which one could argue is sort ofmanipulative of the market and
(14:17):
creates a distortionary effecton the market, which now we're
seeing in California.
And we're seeing it.
We own assets in California.
The last piece on the insurancemarket, I just want to get your
two cents on, Tony, is theadvent of artificial
intelligence and the ability forinsurers to better understand
their risk with ai that's onetheme i've been hearing about
(14:40):
quite a bit from industrycontacts is insurers are
realizing i know this is anotherargument for why rates are
rising they are realizing theywere underwriting risk but
mispricing the risk and with aiand kind of big data and looking
at stuff they've started torealize so like crime scores an
AI overlay of analyzingneighborhoods and crime scores
(15:02):
has started to become a hugeimpact too on insurance
premiums, which I imagine isonly moving premiums up
SPEAKER_01 (15:09):
generally.
Right, because what's happeningand we now use AI every single
day at Union Risk and so do ourinsurance carrier partners or
captive manager partners.
AI is allowing an analyticalportion of risk to be looked at
that was previously never seenbefore or cannot be calculated
(15:30):
fast enough by five people on atraveler's insurance company
team or 10 people on a AIGinsurance company team, where
now we're getting real time dataat the snap of a finger,
basically, from these AI modelsthat not only show you the data
in real time, but can now giveyou a very good prediction of
(15:52):
what might happen in the nextthree, five, 10 years with an
insurance policy, with theamount of premium that's being
paid into it, and what's therisk for the insurance company
and the reinsurance companies tobe truly profitable on this
insurance policy that they justsold.
Because the problem that'shappening is a homeowner's
policy in California that foreasy numbers, we sell for$10,000
(16:15):
a year.
If the loss on that is 15,000,let's say for that policy year,
the insurance company and thereinsurer are underwater on that
policy.
So how do we go and recuperatethat premium and investment
income we just lost?
Have to raise rates.
That's the only way.
And if the losses are that bad,as we've seen in the
marketplace, they start to pullout of certain areas where they
(16:39):
just can't get to premiumpricing that one, makes sense
for them, but two, consumerscould actually afford to buy
because affordability is goingto start becoming a problem if
these insurance companies raisethe rates to where they should
be based on the historical riskdata.
SPEAKER_00 (16:57):
Yeah.
So before we dive into captives,because that's really the
premise of this conversation,although this is incredibly
interesting, I want to stickinto it a little bit longer.
What do you think, this is aloaded question, but what do you
think the next three to fiveyears looks like in the
insurance market?
What do you think is thenecessary conditions for
(17:18):
captives insurance to soften andus to move out of the hard cycle
back into the soft cycle forinsurance?
Because inevitably it willhappen, right?
We have 100 plus years ofhistory to say it.
And I wrote a piece on thetimeless investor, the hard
cycle of insurance, looking at100 years of insurance history.
And one thing's for sure, it iscyclical.
It moves back and forth.
(17:39):
But what do you think are theconditions necessary for
premiums to start softeningmajor carriers?
Because in my...
Tell me if you think this iswrong, but in my view...
you know, we had buildingsinsured for$40,000 a year in
premium and that American familyinsurance and our new insurance
policy is 140,000 a year, right?
Very lucrative.
(17:59):
That building has never had aclaim.
We have no loss history, right?
But they're just collect,someone is collecting another
90, well, my math is wrong,100,000 a year premium from us,
which has got to be profitablefor that insurer.
So then to me, it's like at somepoint, the major carriers, the
frontline tier one carriers willsay, that's a really profitable
(18:20):
space.
Let's go back into it.
But what do you think is thecondition and timing necessary
for that cyclical change to kindof come back in?
So two things have to
SPEAKER_01 (18:32):
happen at scale.
The first is these arecatastrophic events that are
happening.
They need to basically take ayear or two off, hopefully.
Okay.
so that the losses are not theastronomical figures that we've
been seeing for the last five toseven years.
(18:54):
With these losses happening theway that they are, the insurance
companies are so underwater interms of the premiums they were
allocating for to pay theseclaims out that, again, they
have no choice but to raiserates across the board.
So even for your properties thatyou've seen a 3X on that, oh,
this insurance policy itself forAri is, we're in the green 100%,
(19:17):
plus the investment income we'remaking off the policy.
But what you don't see isAmerican Family, the rest of
their portfolio, they might havetaken on loss ratios of more
than 100%.
Because that's also what a lotof people don't understand about
the insurance companies.
They're expecting loss ratiosbetween 80% and 90%.
SPEAKER_00 (19:39):
Because
SPEAKER_01 (19:40):
even with an 80% to 90% loss ratio, the profit
margin there on the policy isstill 10%.
Plus, as that premium is sittingthere, they're gaining another,
depending where they'reinvested, between 5% and 10% on
the money that's sitting.
So when you do this at scale forbillions and billions of
dollars, which is what most ofthese insurance companies are
(20:00):
capitalized at, it could be verylucrative.
The problem is, When you crossover that 95% loss ratio
threshold and you get closer to100 where the premiums are just
out of whack, that's the issuethat's happening.
So if we can mitigate or say aprayer or do a rain dance to
whoever we might do it to,that's going to be the best way
(20:21):
to have premiums that becomemore affordable and get back
into that soft market.
And secondly would be interestrates.
If those drop back down to, youknow, two and a half, two and a
quarter, 2% potentially, it'llallow more players to gain the
liquidity, take the loans outthat they need to recapitalize
(20:43):
and get back into the
SPEAKER_00 (20:45):
marketplace.
That's an interestingperspective because I would
think higher rates means thatinsurers are earning more money
on their float.
So I guess it would go bothways, right?
Because if you have a higher,like if they're investing in
bonds or very secure securities,which I presume is what most
float is invested in, probablymajority, yield type very
(21:05):
conservative instruments andmaybe some smattering of stocks
i would think that theirinvesting profit is higher as a
result of higher interest ratesbut
SPEAKER_01 (21:15):
so to that point yes okay yeah new players coming in
though where hey we maybe we'llspin off a portion of our
insurance company to just goafter this type of risk or a
startup insurance carrier comesinto the fold now they need to
be able to raise the capital andget money on a cheaper basis to
(21:36):
go and make these steps tobecome insurance companies and
to offer rates that, hey, maybewe're 30% less than the market
because we've only been aroundtwo years and we haven't taken
on catastrophic losses.
It allows us to be a player inthe space from a product
offering standpoint.
SPEAKER_00 (21:55):
Okay, incredible.
Yeah, I mean, it's aninteresting time.
So- My thesis and your reach outwas very fortuitous and hence my
excitement to have you on hereand my excitement to talk to you
yesterday was it feels to melike as I've gotten deeper in
the real estate business, I'verealized controlling the cost
inputs is the only real way towin in this business, right?
(22:17):
And so...
And everything, right?
And just to digress briefly,like controlling property
management is controlling a costinput, controlling the
contracting arm of yourbusiness, controlling that cost
input, even like as basic ascontrolling the laundry service
to your asset.
Like we've realized recentlythat we're giving away an
enormous amount of revenue tolaundry servicing companies that
(22:38):
we could control the cost input,control the maintenance spend,
control it.
I don't think people usuallythink of insurance as something
they can control.
And it's a little bit, there'san aspect of it that's not
controllable, but the idea ofcaptives was really interesting
to me because I look at ourportfolio and we have no claims,
right?
We've had none, but our premiumshave gone up three to four X in
(22:59):
many cases.
And it feels like we're gettinglumped in with losses elsewhere.
And like maybe our buildings arejust getting unfairly penalized
or maybe they're fairlypenalized or they're getting
unfairly penalized by the factthat we're in a hard insurance
cycle.
It's probably a mix of all ofthose things.
But the captive model was reallyinteresting and was something I
(23:20):
had looked into before youreached out.
But why don't we pivot now andjust talk a bit about your
primary business and maybe justfor the audience, a quick recap
on what is a captive insurancecompany?
SPEAKER_01 (23:31):
Sure.
So a captive insurance companyis a mini insurance company that
a business or real estate ownercreates for their insurance
portfolio.
So what we're doing is we'retaking...
The same method that WarrenBuffett and Berkshire Hathaway
have used, that AIG has used,that Zurich has used for well
(23:52):
over 100 years.
And we're scaling that down tosize for small, medium, and
middle market types ofbusinesses.
So what we're doing is insteadof paying the insurance expense
to the insurance company andgetting no benefit for that, no
matter what you do, no matterhow good the claims performance
is, we are taking our clientsout of the traditional market,
(24:15):
and creating a captive insurancecompany for them.
With this captive insurancecompany, they are partnering
with an A-rated insurancecarrier, whether that be AIG,
Berkshire, Zurich, whoever itis, to formulate this mini
insurance company where theynow, being our captive, gain the
(24:36):
benefit of good claimsperformance, of low loss ratios.
So after a few years of buildingthe premium into there, the
captive actually sends dividendsnow back to the client or the
real estate owner.
So we're taking the premium thatwe already paid, we're moving
that over into a separatebucket, so we're still paying it
out, but this new bucket is nowthe captive insurance company.
(25:00):
So instead of having a fullexpense on day one, we have that
same expense that's still taxdeductible, but we're putting
that into a brand new asset.
So we're creating a new assetfor our clients on day one of
their new captive insurancepolicy.
The goal is, like you've seen,and like many of the listeners
have seen, take our clients outof the traditional market so
(25:24):
they are not affected and don'thave the crazy rate increases
that have been happeningthroughout the
SPEAKER_00 (25:30):
insurance industry.
Because you have more control.
You have some more control ofthe insurance product.
And there's economic benefits,of course, if you control the
captive that's actually offeringthe risk underwriting to your
properties.
One question I want to doubleclick on.
You mentioned we're taking whatBerkshire, what AIG, what Zurich
(25:51):
have done and bringing it downto the...
Can you just describe?
Because I don't know what thatmeans exactly.
Can you describe what are theydoing that we are replicating
here?
Because in my mind, I justimagined they were just regular
insurance companies.
I didn't realize there wassomething they're doing unique
that we're translating to thelower market.
SPEAKER_01 (26:09):
So I've mentioned investment income a few
different times on this call.
So what happens is as ourpremium is sitting there, it's
gaining that investment incomeinterest year over year, which
compounds.
So average in the captiveinsurance basis is 5%.
Let's say the premium each yearfor simple numbers is 500,000.
(26:30):
We're paying that premium inevery single year.
But as it's sitting there,Throughout four or five years,
it's still gaining that 5% ineach of those different policy
years.
So at scale, that is how WarrenBuffett specifically with
Berkshire, every insurancecompany does it, but he did it
in a way where, of course, forDepartment of Insurance
(26:52):
purposes, you have to have acertain amount of that
investment income completelystabilized and in safe hands.
But the excess of that, he wasable to go and invest in Apple
or Coca-Cola, whatever, he wasdoing with it.
So we're taking that exact modeland just scaling it down to size
for our captive products.
SPEAKER_00 (27:12):
Got it.
Very interesting.
So when we talked yesterday, youmentioned, because I was kind of
asking like, well, how are wereducing the premiums?
And you had mentioned that you,on average, people see a 20, 20%
roughly reduction in premium bygoing to captive route.
Plus you have control of theasset.
Plus you're earning investmentincome on the premium that's
coming into the pot.
(27:33):
Can you, Just walk through themechanics of like, you set it
up, money comes into it.
And this was a question too wehad yesterday, which was, how
are lenders okay with this?
And you had a really insightfulanswer to the way, because my
immediate response was, well, ifI set up a captive and we have,
I don't know, 400,000 of premiuma year we pay, we don't have a
(27:56):
huge pool of float to protectourselves.
And is my lender really going tobe okay with that?
And so I thought you had areally insightful answer to
that.
So if you don't mind just divinginto some of those mechanics,
that'll be amazing for thelisteners.
Sure.
SPEAKER_01 (28:06):
So from the lender standpoint, what we're doing is
we're partnering with theseA-rated, highly financial rated
insurance companies.
Those insurance companies, weare using the policies of their
actual paper.
So on a captive insurancepolicy, it won't say Ari's
Insurance Company, LLC.
(28:27):
It'll say AIG as the actualinsurance company, which we've
never seen a lender, especiallyin real estate, have an issue
when we are presenting AIG paperor Zurich, whoever it might be.
Secondly, in terms of how we'rekeeping those rates down or how
rates decrease from the start,we are now only rating the
(28:50):
insurance policy for Ari basedon Ari's own loss ratios from
the last five years.
So because we are taking thiscompany out of the traditional
insurance market, it's now inits own bubble where the
actuaries will look for the lastfive years of premiums and the
last five years of claims andsay, oh, Ari's actually running
(29:13):
at a 95% profit each year.
He doesn't actually need a 3X onhis insurance.
It could be 20% or 30% lower,and there's still more than
enough premium there to fund forany claims that might happen.
And to build off funding onclaims, we partner with one of
these A-rated carriers becausethey will pay the majority of
(29:36):
each claim that typicallyhappens.
So Ari's company might take onthe first$150,000 of every
claim.
But when it gets past$150,000,the insurance carrier comes in
and they provide the rest of thepayment for a claim that
happened.
SPEAKER_00 (29:53):
Understood.
SPEAKER_01 (29:54):
So those are the ways that we're helping to
mitigate that cost.
SPEAKER_00 (29:57):
I thought that was fascinating too, because I
assume the majority of claimsare under that$150,000 number.
So from the insurance carrier'sperspective, they no longer have
to fund any risk except for likea catastrophic situation,
basically.
Is that true?
Would you say like...
What is it, the 80-20 rule?
Like 80% of your losses areunder or more.
(30:20):
Actually, do you have a numberon that or do you know roughly?
Do most claims fall under thatnumber?
So for our
SPEAKER_01 (30:28):
captive programs, if we take five years and we look
at the last five years of acaptive, four years run great
and you might have one year thathas the potential of having that
excess claim.
So we're looking at a four outof five good performance year
scale.
dealing with any of the captivesthat we have in place right now.
(30:49):
And because captive insuranceyou have to qualify for in terms
of safety, sure, catastrophicevents we can't quantify for, we
don't know what might happen.
But because the safety protocolsare so stringent to get into the
captive, all of our captiveclients and companies that go
into captives have theirstandards at such a level where
(31:12):
they're avoiding most of thetypical risk that companies see
in the traditional insurancemarket because the standard to
get into the traditional marketare a hundred times less than
what they are to get into acaptive.
SPEAKER_00 (31:26):
Okay.
What do you mean by that?
When you say that, like, doesthat mean that they're more
stringent on the assets thatthey'll insure through a
captive?
When you say that, like, I justwant to double click on that
point.
SPEAKER_01 (31:39):
So they'll look at, hey, does Ari have cameras
throughout the building?
If someone slips and falls orfakes a slip and fall, how do we
defend that?
How will we know that'shappening?
Right.
If, you know, are Ari'ssidewalks all paved and nicely
done?
If two of those things aren'thappening, that company, and I'm
(31:59):
just using two examples, thecompany that's trying to get
into a captive might not have achance of getting in until they
make certain improvements.
So the captive is making thestandard improvements for the
insured for the client to getinto the captive more difficult
than it is in the traditionalmarket where most of the time
even if there's an inspectionthat has to be done someone
(32:21):
comes takes three pictures andand leaves whereas with captives
we are trying to secure our riskas much as possible
SPEAKER_00 (32:29):
understood so you mentioned before that insurance
companies anticipated 80 to 90percent loss generally on their
operations is that Is thatroughly how captives perform as
well in your experience when youlook at your portfolio of
captive insurance companies?
SPEAKER_01 (32:45):
No.
The losses across captives areprobably anywhere from 25% to
40%, let's say.
These businesses are so muchhigher standard than businesses
that are still in thetraditional market.
That's really the reason.
SPEAKER_00 (33:06):
Right.
For real estate specifically,how does that manifest itself?
Is it difficult to insurethrough a captive product older
buildings?
Because that's really where thedifficulty has been with
insurance.
If you have a Class A new build,it's easy to find insurance.
All the main carriers will stillcover it.
The question, I guess, is canyou set up a captive with older
(33:29):
vintage buildings with more...
more challenging systems issues,right?
That are like, there is nomarket for those assets right
now.
To me, that's the question islike, is that something one can
do in this business?
Or is the captive program reallymeant for someone that owns a
thousand class A units that arebrand new and they're just
(33:49):
trying to control their ownpremium costs?
Or is
SPEAKER_01 (33:51):
it both?
So the minimum premium we lookat for a captive is somewhere in
the$250,000 range.
And for the real estate captiveswe do, that includes property
and general liability.
insurance.
The beauty of captives, and youmentioned the age of the
buildings just now, we are onlylooking at the claims data to
say this makes sense or thisdoes not make sense for a
(34:14):
captive.
If Ari's been performing at a70% loss ratio over the last
five years, the captive managermight say, this might not make
sense right now.
Let's try to get some safetystandards in place and make the
loss ratio more palatable forfrom a profit perspective.
But if that loss ratio is closeto or under 40%, then there's
(34:37):
real profit there.
Or zero.
Or zero.
Or zero.
Knocking on wood.
Knocking on wood.
Knock on wood indeed.
That good Oregon wood you haveout there.
Yeah, exactly.
That's what we're looking for isanywhere under 40.
It could be a little more if thescale's there for the size of
the business we're looking at.
But that's what we like to see.
(34:58):
So the judgment is only off ofthe claims data itself.
SPEAKER_00 (35:02):
Okay, amazing.
Yeah, look, I think I've had atheory that as this market gets
more crazy and difficult, thatpeople were going to start
looking for unique andalternative solutions to solve
this problem and to control thecost input.
And I think, honestly, I thinkthis is a genius approach and
something I've been reallyinterested in.
What...
(35:23):
How do people, I'm going to putyour information in the show
notes so people will be able toreach out to you.
But what would you say is likethe classic business owner
scenario?
Because we have listeners thatare just business owners as
well, right?
They're not all real estatefolks.
What would you say is the idealsituation where you're like, we
(35:43):
can help you.
We can do this for you.
What do you think is the rightclient for you?
SPEAKER_01 (35:49):
Sure.
Ideally, as long as thebusiness, and whether that's a
manufacturer, constructioncompany, transportation company,
a real estate company, as longas they're paying a minimum of
$250,000 a year in premium, andthey have good claims
performance, which is somewherein that below 40% range, if you
(36:10):
just divide your claims by yourpremium, that's the loss ratio
that we're looking for, we canstart conversations with those
businesses.
The more premium, the easier.
Because there's moredistribution to be had.
Some of our clients have$5million,$10 million,$1 million
of premium.
It makes the deals a littleeasier to formulate because
(36:30):
there's more premium there towork with.
But a minimum of$250 and that40% loss ratio is what we're
looking for just
SPEAKER_00 (36:40):
as a pre-qual.
Incredible.
And what...
This is sort of a loaded topic,too.
What tax benefits, if any, arethere to setting up this kind of
program?
Because I could be incorrect onthis understanding.
I've understood that there aresome tax benefits as well to
doing something like this.
Obviously, premiums paid or atax write-off to the building.
Are there any other, or no, arethere any other tax benefits
(37:03):
that accrue to ownership or topeople that run these programs?
SPEAKER_01 (37:07):
Yeah.
For this question, it alldepends what kind of captive
we're going into.
There's group captives that aredomiciled in the Caribbean, in
the Caymans or Bermuda, wheretheir dividends are taxed going
back into the United States andthen into– we typically like a
trust to be set up for companiesthat are getting the dividends
(37:28):
returned from them.
But then you have some singleparent captives, which is you're
just in the captive all byyourself that are domiciled in
the United States, which have alittle more tax benefits because
they're not getting the doubletax on the premium or the
dividends being sent back fromthe Caribbean into the United
States.
So it all depends what type ofcaptive setup we have, but
(37:50):
you're still definitely gettingthe tax deduction on the premium
expense.
And then your mini insurancecompany, If the premium is under
2.85 million, we could takewhat's called an 831B tax
election where only theinvestment income for that new
insurance company is taxed.
(38:10):
The actual revenue that wentinto from your expense that
turned into revenue because it'sgoing into your captive, the
revenue is not taxed if it'sunder that 2.85 million
SPEAKER_00 (38:21):
mark for premium.
That's incredible.
So- Theoretically, just forround numbers, if you're
bringing in a million dollars ofpremium and that's revenue,
you're saying that milliondollars of premium is not taxed.
Only the investment income on itis taxed.
SPEAKER_01 (38:35):
If we take the A31B election, yes, the A31B election
has been scrutinized by the IRSa bit.
Because what happens isbusinesses or individuals set up
captives that are not actuallyinsuring for a true insurable
risk.
Right.
As
SPEAKER_00 (38:55):
a tax write-off.
SPEAKER_01 (38:56):
Exactly.
We're insuring for true risk.
We have actuaries.
We have captive managers.
We have true property riskbecause there's property that's
being insured.
There's general liability riskthat we're insuring for.
So we don't see those issues.
But with that tax election, theIRS does look at it as...
Okay, let's look a little moreinto it because you have this
(39:19):
asset now that just...
the individual expense, onepayment, put it into the
captive, and the revenue or thepremium is not over the 2.8
threshold, we're going to takethe election and not pay tax
SPEAKER_00 (39:33):
on it.
Incredible.
I mean, I didn't know that.
So that's a monster tax benefit.
But it sort of makes sense, too,because theoretically money
coming into your captive mayhave to go back out.
And it would be a difficultsituation to pay tax on money
coming in that you then have topay back out as losses.
Right,
SPEAKER_01 (39:48):
which creates underfunding.
SPEAKER_00 (39:50):
Totally.
So that makes a lot of sense.
Yeah, this is an incrediblypowerful program.
We are going to be working herewith Tony to try to set up our
own captive for the benefit ofour investors.
I think it's a huge opportunityto control a massive cost input
in this business.
I think it's a huge opportunity.
And I'm thrilled to have Tonyhere to talk through this
(40:11):
program.
I will provide his informationin the show notes and This
episode was so good that I saidin the beginning that it was
going to be premium only, and weare going to release it early to
the premium subscribers.
But I think I'm going to justalso include this in the
Timeless Investor Show becausepeople need to hear this.
This is a great story.
(40:32):
This is a really interestingprogram.
And these are the kind ofsolutions that astute operators
really need to think about.
So, Tony, thank you for being onwith us.
And it was a pleasure.
And I'll leave you all with theclassic podcast.
timeless investor sign off,which is think well, act wisely,
build something timeless.
(40:52):
We're doing this together.
We're sharing awesome Intel andreally grateful to Tony to be a
subscriber to our newsletter andto join us today.
Please reach out to him.
If you want to learn more aboutthis, we're going to do it
ourselves.
Thank you, Tony.
Thank you, Art.
Hello, everybody.
Welcome to another episode ofthe Timeless Investor Show
Premium for our paid subscribersto the Timeless Investor
Newsletter.
I'm incredibly excited to behere.
This is just full disclosure foreveryone.
This is my first actualinterview with someone.
We obviously run a podcast showand I do a lot of solo episodes.
(00:21):
So Tony here is going to be ourtest subject.
And brought directly to you guysto hear some incredible intel
and really exciting stuff that Ijust learned yesterday.
Tony is a subscriber to theTimeless Investor Show.
So we are building a really coolcommunity here.
He actually reached out to meand was interested in what we
(00:41):
were doing.
And we had this incredibleconversation, which...
Literally, we talked yesterdayand I was like, I've got to get
this going ASAP for everyone.
This is incredible intel, reallyvaluable insights, something
I've been thinking about a lot.
So I want to introduce you guysto Tony DeFede with Union Risk.
His firm specializes in settingup captive insurance programs
(01:03):
for operators of real estate andany other business all across
the country.
This is a strategy that...
The big boys have been using fora long time to control insurance
costs and premiums.
And Tony's team makes itavailable for everybody, right?
I mean, you still have to have afairly large portfolio and quite
(01:24):
a bit of stuff.
But just quickly before I letTony take off, I just wanted to
set the framework here.
So most of you are real estateinvestors or business owners and
everyone is sort of dealing witha really brutal situation.
insurance premium environment.
And we've talked about it.
We wrote pieces on the hardcycle of insurance over time.
And the insurance industry isthis incredibly cyclical beast,
(01:47):
right?
And we're in a hard cycle rightnow.
And I'm really looking forwardto hearing Tony's analyses of
kind of what's going on.
But for ourselves, we've seeninsurance premiums go up 2X, 3X.
All the major carriers areexiting.
American Family was a hugeinsurance company we worked with
all across the PacificNorthwest, and they completely
dumped multifamily risk, andit's caused premiums to rise
(02:10):
everywhere.
State Farm is exitingCalifornia.
It's a really bearish time forinsurance, and this is the time,
and this is why I'm reallyexcited about this, and we're
going to try to do this with theLombard Equities portfolio and
other partners we have in thismarket.
This is the time for creative,unique solutions, and Tony has
got it.
So, Tony...
Please introduce yourself andtell us your analyses of the
(02:33):
insurance market, and then let'sdive into captives.
SPEAKER_01 (02:36):
Sure.
All right.
Well, thank you for having me.
I am Tony DeFede, the partnerand the chief risk officer at
Union Risk Services.
Union Risk is a captiveinsurance specialty brokerage
located in New Jersey,specializing in captive
insurance for companies doingbetween$5 million a year in
revenue and close to a billion ayear in revenue and everywhere.
(03:00):
in between.
With where the insurance marketis right now, as I'm sure
everyone listening knows this,we are in the hardest insurance
market from what I have seen andfrom what I've heard from
industry veterans and Mohegansin the last 50 to 100 years
without a doubt.
These last five years ininsurance have been the toughest
(03:23):
time for the insurance industry.
And what does that mean?
That means for the payers ofinsurance, which are people like
Ari and the people listening tothis podcast right now, rates
are doubling, tripling,quadrupling in some cases.
Now, why is this happening?
Catastrophes have one thing todo with that.
(03:43):
Over the last five to sevenyears, over$50 billion in
catastrophe costs costs havebeen paid out by insurance
companies or are set to be paidout by insurance companies,
which they have to prepare for.
So that's one reason why nomatter if you have a car for car
insurance or homeowner'sinsurance, or if you're like Ari
(04:05):
and own a ton of real estate andmany doors, your insurance costs
are going up no matter what,because the insurance companies
themselves are in a position nowwhere they have to fund for
these massive claims which haveoccurred in the past five to
seven years.
And they are trying to makemoney on top of that.
And the only way to do that isto set the insurance increases
(04:26):
that we've been seeing for thelongest time.
Prior to the hard market wasprobably the best insurance
market in history.
And what leads to a greatinsurance market?
It's a few things.
The level of catastrophes were alittle less.
And all you need is a littlearbitrage there for insurance
companies to make the money theyneed to make from the investment
(04:47):
income, which is something weutilize with captive insurance.
The investment income for theseinsurance companies is how they
make all their money.
Even if their loss ratios are100%, meaning any premium that's
been paid in for a policy getspaid back out for expenses, they
are still making money on thatinsurance premium as it sits
there, which is what we do withcaptive insurance.
(05:10):
So when you have a soft marketlike we had, the liquidity was
plenty, the losses were a littlemore contained Right.
(05:40):
Certain premium numbers.
SPEAKER_00 (05:41):
And the timing, it's interesting too, like the timing
of the soft cycle and insurancereally coincided with incredibly
low interest rates as well,which is sort of, which we talk
about, you know, real estateisn't a bear market today.
And one of the factors that'scrushing real estate is interest
rates, right?
Interest rates have doubled ortripled in many cases.
And a lot of poorly underwrittendeals are really underperforming
(06:03):
now.
But the thing that I, I mean, wetalk about interest rate cycles
a lot.
in real estate because it'sincredibly critical to the
valuation of real estate.
But the input costs into runningproperties have risen
dramatically.
Payroll is up, right?
I mean, all driven by inflation.
But the thing that is reallytorpedoing a lot of deals is
(06:24):
that we...
So like on top of an interestrate increase, we've also have
this environment where premiumsare up two to three X.
And no one...
When you underwrite a realestate deal, it's like, you just
estimate 3%, 4%, 2%, somethingin that range, annual expense
increases.
I don't think anybody, anybodyin the entire real estate
business forecast 30% to 40%annual increases on insurance
(06:47):
premium, which is kind of whatwe're seeing.
Unless you have the highestquality asset that is brand new,
everybody else is gettingcrushed, which happens to be
most of the market.
One of the things I realizedwhen researching this more is
the It seems like one of thefactors that's really crushing
premiums is the reinsurancemarket has been really heavily
(07:08):
hit.
So reinsurers, from myunderstanding, are sort of
pulling back from underwritingrisk.
And that is also causing adownstream effect, right?
Because these insurance...
And I think for edification ofthe audience too, how does that
work?
The mainline carriers offset therisk to reinsurance, but if
reinsurance starts pullingout...
I think Swiss Re was sayingthey've had some massive amount
(07:31):
of claims and losses due tonatural catastrophes.
Also, the social unrest duringCOVID, like big buildings
burning down or being severelydamaged.
What effect have you seen?
I mean, that is obviously a hugeimpact.
Is that something you're seeing?
SPEAKER_01 (07:46):
Without a doubt.
Just for everyone who'slistening right now, reinsurance
is insurance for an insurancecompany.
So when an insurance carrier isgoing to write specific classes
of business, in this case, let'ssay real estate for Ari's
listeners, they are actuallygetting a sign-off approval from
their reinsurance company.
(08:07):
But what's been happeningbecause of these massive claims
we've been seeing for the lastfive to seven years, the
reinsurance companies have hadto pay claims or take on parts
of claims for their insurancecompany clients.
So when this happens now, areinsurance company sits back
after year end of 2024 and sees,oh, we are actually at a minus
(08:30):
of 15% across our reinsuranceportfolio.
So we're actually losing moneyon insuring our insurance
companies.
How do we stop this?
One way to do that is to raisethe reinsurance costs on
insurance companies, which inturn gets put onto the consumer.
In this case- RE and Lombardequities.
(08:51):
And another way they do this isby tightening their risk
appetite.
When you have insurancecompanies that have tightened
their risk appetite like theyhave for the last five to seven
years, there are just not asmany players in the marketplace
as there were in 2015, 2016,2017.
So all of this is the perfectstorm for the hardest insurance
(09:13):
market in history.
SPEAKER_00 (09:15):
Yeah.
Well, that's a critical piece.
And I feel like a lot of folksdon't fully understand or
respect the impact ofreinsurance on insurance, right?
Because insurance companiesaren't taking all the risk, like
you said.
And their ability to offer theirpremiums is because they offset
some risk.
And if that risk offsetting getspricey, that flows down to us.
(09:35):
The other thing, I'm kind ofcurious your perspective on
this.
Obviously, natural disastershave been rising.
um you know the the 10-year100-year storm is now like in
every other year occurrenceright florida hurricanes are a
really good example we've had adramatic increase in really
adverse weather eventscalifornia with the wildfires i
would argue it's also a climatechange related difference right
(09:59):
i mean i like i look at it fromthe pacific northwest i live in
oregon oregon's temperaturebands have risen over the last
10 years oregon is actually Iwould say a net beneficiary of
climate change because theweather has been getting warmer
and nicer.
It's almost like the newCalifornia.
And I'm from California.
When I go back to California,it's hotter, right?
It's hotter and it's drier.
(10:20):
And it's like that.
So the question that I wonder iswhen big weather events happen
in Florida or California, or youhave a Texas like major freeze,
right?
Texas is another market whereinsurance is really, really
difficult.
That has a knock on Ram.
So like, A lot of folks will belike, well, I invest in X market
(10:40):
where we don't haveweather-related events and other
problems.
But they're the same risk poolsthat are covering Florida as are
covering...
I don't know.
I can't think of a non-riskymarket.
But somewhere in the Midwestwhere they don't have tornadoes
and there's no bigweather-related problems.
But their premiums, I presume,are also rising because those
(11:01):
insurance companies are tryingto offset their risk in Florida
and California and othermarkets.
I mean, is that accurate tosay...
Natural weather patterns inparts of the globe that have no
impact on your market still havean impact on your premiums
because they have to offset thecost, right?
SPEAKER_01 (11:17):
Right.
That's exactly what's happeningis you have State Farm in
California, let's say, who justgot blown out of the water
because of the wildfires andother natural disasters.
Now we have State Farm in NewYork, who is all of a sudden
non-renewing auto liability riskfor transportation companies
because that risk is in New Yorkcoupled with the risk in
(11:39):
California is just not worth theoverall risk to a company like
State Farm.
So what happens now?
A major insurance player likeState Farm pulls out of New York
for transportation companies.
Now all of a sudden,transportation companies in New
York, instead of there beingfour major players, there might
only be three or two.
What happens then?
Because they've also taken onlosses, premiums just continue
(12:03):
to rise across the board.
So there is a correlation evenwith different insurance
companies, with their offeringsbeing affected by other carriers
SPEAKER_00 (12:13):
as well.
Right.
Well, it's going to beinteresting too.
For those of the listeners thatare investors in California or
homeowners in California, one ofthe things I've been watching
pretty closely is California–has been very successful at
artificially suppressinginsurance premiums in their
market.
And that is the reason most ofthese carriers are exiting
(12:34):
California because they're notallowed to raise premiums the
level they want to raisepremiums.
And for example, my home inPortland, I pay about$1,000 a
year for my homeowner'sinsurance.
And I have many, obviously fromthe Bay Area, many friends who
pay$6,000 to$7,000 a year rightnow for their homeowner's
premium.
And that is a suppressedpremium.
rate in california because thecalifornia insurance commission
(12:55):
won't allow them to raise ratesso this is giant game of chicken
what's this is a total tangentbut what's really alarming about
that if you're a californian orany other market that has an
artificially suppressed premiumenvironment is eventually
california i mean californiacan't play that game forever
they need to have insurers andcalifornia can't underwrite all
(13:15):
the risks themselves What Ithink will happen is they'll
have to capitulate.
And then if they let premiumsfloat to the level they actually
have to be in market, it's goingto be a double or tripling of
homeowners insurance premiums,which has a serious knock-on
effect.
If you think about your abilityto afford a home in California,
(13:37):
if the premium triples forhomeowners insurance, what does
that do to home values inCalifornia?
And actually, it's even moreIt's even more nefarious because
California's Prop 13 controlsproperty tax rates, right?
But you reset your property taxrate based on the purchase price
of the home.
So California is in a really bigpickle right now because if they
(13:57):
let premiums float, home pricestank and their property tax
revenue will start to drop.
People will be reassessingproperty tax rates, all this
kind of stuff.
So it's a really diceysituation, you know, driven by
some government policyinvolvement in the business,
which one could argue is sort ofmanipulative of the market and
(14:17):
creates a distortionary effecton the market, which now we're
seeing in California.
And we're seeing it.
We own assets in California.
The last piece on the insurancemarket, I just want to get your
two cents on, Tony, is theadvent of artificial
intelligence and the ability forinsurers to better understand
their risk with ai that's onetheme i've been hearing about
(14:40):
quite a bit from industrycontacts is insurers are
realizing i know this is anotherargument for why rates are
rising they are realizing theywere underwriting risk but
mispricing the risk and with aiand kind of big data and looking
at stuff they've started torealize so like crime scores an
AI overlay of analyzingneighborhoods and crime scores
(15:02):
has started to become a hugeimpact too on insurance
premiums, which I imagine isonly moving premiums up
SPEAKER_01 (15:09):
generally.
Right, because what's happeningand we now use AI every single
day at Union Risk and so do ourinsurance carrier partners or
captive manager partners.
AI is allowing an analyticalportion of risk to be looked at
that was previously never seenbefore or cannot be calculated
(15:30):
fast enough by five people on atraveler's insurance company
team or 10 people on a AIGinsurance company team, where
now we're getting real time dataat the snap of a finger,
basically, from these AI modelsthat not only show you the data
in real time, but can now giveyou a very good prediction of
(15:52):
what might happen in the nextthree, five, 10 years with an
insurance policy, with theamount of premium that's being
paid into it, and what's therisk for the insurance company
and the reinsurance companies tobe truly profitable on this
insurance policy that they justsold.
Because the problem that'shappening is a homeowner's
policy in California that foreasy numbers, we sell for$10,000
(16:15):
a year.
If the loss on that is 15,000,let's say for that policy year,
the insurance company and thereinsurer are underwater on that
policy.
So how do we go and recuperatethat premium and investment
income we just lost?
Have to raise rates.
That's the only way.
And if the losses are that bad,as we've seen in the
marketplace, they start to pullout of certain areas where they
(16:39):
just can't get to premiumpricing that one, makes sense
for them, but two, consumerscould actually afford to buy
because affordability is goingto start becoming a problem if
these insurance companies raisethe rates to where they should
be based on the historical riskdata.
SPEAKER_00 (16:57):
Yeah.
So before we dive into captives,because that's really the
premise of this conversation,although this is incredibly
interesting, I want to stickinto it a little bit longer.
What do you think, this is aloaded question, but what do you
think the next three to fiveyears looks like in the
insurance market?
What do you think is thenecessary conditions for
(17:18):
captives insurance to soften andus to move out of the hard cycle
back into the soft cycle forinsurance?
Because inevitably it willhappen, right?
We have 100 plus years ofhistory to say it.
And I wrote a piece on thetimeless investor, the hard
cycle of insurance, looking at100 years of insurance history.
And one thing's for sure, it iscyclical.
It moves back and forth.
(17:39):
But what do you think are theconditions necessary for
premiums to start softeningmajor carriers?
Because in my...
Tell me if you think this iswrong, but in my view...
you know, we had buildingsinsured for$40,000 a year in
premium and that American familyinsurance and our new insurance
policy is 140,000 a year, right?
Very lucrative.
(17:59):
That building has never had aclaim.
We have no loss history, right?
But they're just collect,someone is collecting another
90, well, my math is wrong,100,000 a year premium from us,
which has got to be profitablefor that insurer.
So then to me, it's like at somepoint, the major carriers, the
frontline tier one carriers willsay, that's a really profitable
(18:20):
space.
Let's go back into it.
But what do you think is thecondition and timing necessary
for that cyclical change to kindof come back in?
So two things have to
SPEAKER_01 (18:32):
happen at scale.
The first is these arecatastrophic events that are
happening.
They need to basically take ayear or two off, hopefully.
Okay.
so that the losses are not theastronomical figures that we've
been seeing for the last five toseven years.
(18:54):
With these losses happening theway that they are, the insurance
companies are so underwater interms of the premiums they were
allocating for to pay theseclaims out that, again, they
have no choice but to raiserates across the board.
So even for your properties thatyou've seen a 3X on that, oh,
this insurance policy itself forAri is, we're in the green 100%,
(19:17):
plus the investment income we'remaking off the policy.
But what you don't see isAmerican Family, the rest of
their portfolio, they might havetaken on loss ratios of more
than 100%.
Because that's also what a lotof people don't understand about
the insurance companies.
They're expecting loss ratiosbetween 80% and 90%.
SPEAKER_00 (19:39):
Because
SPEAKER_01 (19:40):
even with an 80% to 90% loss ratio, the profit
margin there on the policy isstill 10%.
Plus, as that premium is sittingthere, they're gaining another,
depending where they'reinvested, between 5% and 10% on
the money that's sitting.
So when you do this at scale forbillions and billions of
dollars, which is what most ofthese insurance companies are
(20:00):
capitalized at, it could be verylucrative.
The problem is, When you crossover that 95% loss ratio
threshold and you get closer to100 where the premiums are just
out of whack, that's the issuethat's happening.
So if we can mitigate or say aprayer or do a rain dance to
whoever we might do it to,that's going to be the best way
(20:21):
to have premiums that becomemore affordable and get back
into that soft market.
And secondly would be interestrates.
If those drop back down to, youknow, two and a half, two and a
quarter, 2% potentially, it'llallow more players to gain the
liquidity, take the loans outthat they need to recapitalize
(20:43):
and get back into the
SPEAKER_00 (20:45):
marketplace.
That's an interestingperspective because I would
think higher rates means thatinsurers are earning more money
on their float.
So I guess it would go bothways, right?
Because if you have a higher,like if they're investing in
bonds or very secure securities,which I presume is what most
float is invested in, probablymajority, yield type very
(21:05):
conservative instruments andmaybe some smattering of stocks
i would think that theirinvesting profit is higher as a
result of higher interest ratesbut
SPEAKER_01 (21:15):
so to that point yes okay yeah new players coming in
though where hey we maybe we'llspin off a portion of our
insurance company to just goafter this type of risk or a
startup insurance carrier comesinto the fold now they need to
be able to raise the capital andget money on a cheaper basis to
(21:36):
go and make these steps tobecome insurance companies and
to offer rates that, hey, maybewe're 30% less than the market
because we've only been aroundtwo years and we haven't taken
on catastrophic losses.
It allows us to be a player inthe space from a product
offering standpoint.
SPEAKER_00 (21:55):
Okay, incredible.
Yeah, I mean, it's aninteresting time.
So- My thesis and your reach outwas very fortuitous and hence my
excitement to have you on hereand my excitement to talk to you
yesterday was it feels to melike as I've gotten deeper in
the real estate business, I'verealized controlling the cost
inputs is the only real way towin in this business, right?
(22:17):
And so...
And everything, right?
And just to digress briefly,like controlling property
management is controlling a costinput, controlling the
contracting arm of yourbusiness, controlling that cost
input, even like as basic ascontrolling the laundry service
to your asset.
Like we've realized recentlythat we're giving away an
enormous amount of revenue tolaundry servicing companies that
(22:38):
we could control the cost input,control the maintenance spend,
control it.
I don't think people usuallythink of insurance as something
they can control.
And it's a little bit, there'san aspect of it that's not
controllable, but the idea ofcaptives was really interesting
to me because I look at ourportfolio and we have no claims,
right?
We've had none, but our premiumshave gone up three to four X in
(22:59):
many cases.
And it feels like we're gettinglumped in with losses elsewhere.
And like maybe our buildings arejust getting unfairly penalized
or maybe they're fairlypenalized or they're getting
unfairly penalized by the factthat we're in a hard insurance
cycle.
It's probably a mix of all ofthose things.
But the captive model was reallyinteresting and was something I
(23:20):
had looked into before youreached out.
But why don't we pivot now andjust talk a bit about your
primary business and maybe justfor the audience, a quick recap
on what is a captive insurancecompany?
SPEAKER_01 (23:31):
Sure.
So a captive insurance companyis a mini insurance company that
a business or real estate ownercreates for their insurance
portfolio.
So what we're doing is we'retaking...
The same method that WarrenBuffett and Berkshire Hathaway
have used, that AIG has used,that Zurich has used for well
(23:52):
over 100 years.
And we're scaling that down tosize for small, medium, and
middle market types ofbusinesses.
So what we're doing is insteadof paying the insurance expense
to the insurance company andgetting no benefit for that, no
matter what you do, no matterhow good the claims performance
is, we are taking our clientsout of the traditional market,
(24:15):
and creating a captive insurancecompany for them.
With this captive insurancecompany, they are partnering
with an A-rated insurancecarrier, whether that be AIG,
Berkshire, Zurich, whoever itis, to formulate this mini
insurance company where theynow, being our captive, gain the
(24:36):
benefit of good claimsperformance, of low loss ratios.
So after a few years of buildingthe premium into there, the
captive actually sends dividendsnow back to the client or the
real estate owner.
So we're taking the premium thatwe already paid, we're moving
that over into a separatebucket, so we're still paying it
out, but this new bucket is nowthe captive insurance company.
(25:00):
So instead of having a fullexpense on day one, we have that
same expense that's still taxdeductible, but we're putting
that into a brand new asset.
So we're creating a new assetfor our clients on day one of
their new captive insurancepolicy.
The goal is, like you've seen,and like many of the listeners
have seen, take our clients outof the traditional market so
(25:24):
they are not affected and don'thave the crazy rate increases
that have been happeningthroughout the
SPEAKER_00 (25:30):
insurance industry.
Because you have more control.
You have some more control ofthe insurance product.
And there's economic benefits,of course, if you control the
captive that's actually offeringthe risk underwriting to your
properties.
One question I want to doubleclick on.
You mentioned we're taking whatBerkshire, what AIG, what Zurich
(25:51):
have done and bringing it downto the...
Can you just describe?
Because I don't know what thatmeans exactly.
Can you describe what are theydoing that we are replicating
here?
Because in my mind, I justimagined they were just regular
insurance companies.
I didn't realize there wassomething they're doing unique
that we're translating to thelower market.
SPEAKER_01 (26:09):
So I've mentioned investment income a few
different times on this call.
So what happens is as ourpremium is sitting there, it's
gaining that investment incomeinterest year over year, which
compounds.
So average in the captiveinsurance basis is 5%.
Let's say the premium each yearfor simple numbers is 500,000.
(26:30):
We're paying that premium inevery single year.
But as it's sitting there,Throughout four or five years,
it's still gaining that 5% ineach of those different policy
years.
So at scale, that is how WarrenBuffett specifically with
Berkshire, every insurancecompany does it, but he did it
in a way where, of course, forDepartment of Insurance
(26:52):
purposes, you have to have acertain amount of that
investment income completelystabilized and in safe hands.
But the excess of that, he wasable to go and invest in Apple
or Coca-Cola, whatever, he wasdoing with it.
So we're taking that exact modeland just scaling it down to size
for our captive products.
SPEAKER_00 (27:12):
Got it.
Very interesting.
So when we talked yesterday, youmentioned, because I was kind of
asking like, well, how are wereducing the premiums?
And you had mentioned that you,on average, people see a 20, 20%
roughly reduction in premium bygoing to captive route.
Plus you have control of theasset.
Plus you're earning investmentincome on the premium that's
coming into the pot.
(27:33):
Can you, Just walk through themechanics of like, you set it
up, money comes into it.
And this was a question too wehad yesterday, which was, how
are lenders okay with this?
And you had a really insightfulanswer to the way, because my
immediate response was, well, ifI set up a captive and we have,
I don't know, 400,000 of premiuma year we pay, we don't have a
(27:56):
huge pool of float to protectourselves.
And is my lender really going tobe okay with that?
And so I thought you had areally insightful answer to
that.
So if you don't mind just divinginto some of those mechanics,
that'll be amazing for thelisteners.
Sure.
SPEAKER_01 (28:06):
So from the lender standpoint, what we're doing is
we're partnering with theseA-rated, highly financial rated
insurance companies.
Those insurance companies, weare using the policies of their
actual paper.
So on a captive insurancepolicy, it won't say Ari's
Insurance Company, LLC.
(28:27):
It'll say AIG as the actualinsurance company, which we've
never seen a lender, especiallyin real estate, have an issue
when we are presenting AIG paperor Zurich, whoever it might be.
Secondly, in terms of how we'rekeeping those rates down or how
rates decrease from the start,we are now only rating the
(28:50):
insurance policy for Ari basedon Ari's own loss ratios from
the last five years.
So because we are taking thiscompany out of the traditional
insurance market, it's now inits own bubble where the
actuaries will look for the lastfive years of premiums and the
last five years of claims andsay, oh, Ari's actually running
(29:13):
at a 95% profit each year.
He doesn't actually need a 3X onhis insurance.
It could be 20% or 30% lower,and there's still more than
enough premium there to fund forany claims that might happen.
And to build off funding onclaims, we partner with one of
these A-rated carriers becausethey will pay the majority of
(29:36):
each claim that typicallyhappens.
So Ari's company might take onthe first$150,000 of every
claim.
But when it gets past$150,000,the insurance carrier comes in
and they provide the rest of thepayment for a claim that
happened.
SPEAKER_00 (29:53):
Understood.
SPEAKER_01 (29:54):
So those are the ways that we're helping to
mitigate that cost.
SPEAKER_00 (29:57):
I thought that was fascinating too, because I
assume the majority of claimsare under that$150,000 number.
So from the insurance carrier'sperspective, they no longer have
to fund any risk except for likea catastrophic situation,
basically.
Is that true?
Would you say like...
What is it, the 80-20 rule?
Like 80% of your losses areunder or more.
(30:20):
Actually, do you have a numberon that or do you know roughly?
Do most claims fall under thatnumber?
So for our
SPEAKER_01 (30:28):
captive programs, if we take five years and we look
at the last five years of acaptive, four years run great
and you might have one year thathas the potential of having that
excess claim.
So we're looking at a four outof five good performance year
scale.
dealing with any of the captivesthat we have in place right now.
(30:49):
And because captive insuranceyou have to qualify for in terms
of safety, sure, catastrophicevents we can't quantify for, we
don't know what might happen.
But because the safety protocolsare so stringent to get into the
captive, all of our captiveclients and companies that go
into captives have theirstandards at such a level where
(31:12):
they're avoiding most of thetypical risk that companies see
in the traditional insurancemarket because the standard to
get into the traditional marketare a hundred times less than
what they are to get into acaptive.
SPEAKER_00 (31:26):
Okay.
What do you mean by that?
When you say that, like, doesthat mean that they're more
stringent on the assets thatthey'll insure through a
captive?
When you say that, like, I justwant to double click on that
point.
SPEAKER_01 (31:39):
So they'll look at, hey, does Ari have cameras
throughout the building?
If someone slips and falls orfakes a slip and fall, how do we
defend that?
How will we know that'shappening?
Right.
If, you know, are Ari'ssidewalks all paved and nicely
done?
If two of those things aren'thappening, that company, and I'm
(31:59):
just using two examples, thecompany that's trying to get
into a captive might not have achance of getting in until they
make certain improvements.
So the captive is making thestandard improvements for the
insured for the client to getinto the captive more difficult
than it is in the traditionalmarket where most of the time
even if there's an inspectionthat has to be done someone
(32:21):
comes takes three pictures andand leaves whereas with captives
we are trying to secure our riskas much as possible
SPEAKER_00 (32:29):
understood so you mentioned before that insurance
companies anticipated 80 to 90percent loss generally on their
operations is that Is thatroughly how captives perform as
well in your experience when youlook at your portfolio of
captive insurance companies?
SPEAKER_01 (32:45):
No.
The losses across captives areprobably anywhere from 25% to
40%, let's say.
These businesses are so muchhigher standard than businesses
that are still in thetraditional market.
That's really the reason.
SPEAKER_00 (33:06):
Right.
For real estate specifically,how does that manifest itself?
Is it difficult to insurethrough a captive product older
buildings?
Because that's really where thedifficulty has been with
insurance.
If you have a Class A new build,it's easy to find insurance.
All the main carriers will stillcover it.
The question, I guess, is canyou set up a captive with older
(33:29):
vintage buildings with more...
more challenging systems issues,right?
That are like, there is nomarket for those assets right
now.
To me, that's the question islike, is that something one can
do in this business?
Or is the captive program reallymeant for someone that owns a
thousand class A units that arebrand new and they're just
(33:49):
trying to control their ownpremium costs?
Or is
SPEAKER_01 (33:51):
it both?
So the minimum premium we lookat for a captive is somewhere in
the$250,000 range.
And for the real estate captiveswe do, that includes property
and general liability.
insurance.
The beauty of captives, and youmentioned the age of the
buildings just now, we are onlylooking at the claims data to
say this makes sense or thisdoes not make sense for a
(34:14):
captive.
If Ari's been performing at a70% loss ratio over the last
five years, the captive managermight say, this might not make
sense right now.
Let's try to get some safetystandards in place and make the
loss ratio more palatable forfrom a profit perspective.
But if that loss ratio is closeto or under 40%, then there's
(34:37):
real profit there.
Or zero.
Or zero.
Or zero.
Knocking on wood.
Knocking on wood.
Knock on wood indeed.
That good Oregon wood you haveout there.
Yeah, exactly.
That's what we're looking for isanywhere under 40.
It could be a little more if thescale's there for the size of
the business we're looking at.
But that's what we like to see.
(34:58):
So the judgment is only off ofthe claims data itself.
SPEAKER_00 (35:02):
Okay, amazing.
Yeah, look, I think I've had atheory that as this market gets
more crazy and difficult, thatpeople were going to start
looking for unique andalternative solutions to solve
this problem and to control thecost input.
And I think, honestly, I thinkthis is a genius approach and
something I've been reallyinterested in.
What...
(35:23):
How do people, I'm going to putyour information in the show
notes so people will be able toreach out to you.
But what would you say is likethe classic business owner
scenario?
Because we have listeners thatare just business owners as
well, right?
They're not all real estatefolks.
What would you say is the idealsituation where you're like, we
(35:43):
can help you.
We can do this for you.
What do you think is the rightclient for you?
SPEAKER_01 (35:49):
Sure.
Ideally, as long as thebusiness, and whether that's a
manufacturer, constructioncompany, transportation company,
a real estate company, as longas they're paying a minimum of
$250,000 a year in premium, andthey have good claims
performance, which is somewherein that below 40% range, if you
(36:10):
just divide your claims by yourpremium, that's the loss ratio
that we're looking for, we canstart conversations with those
businesses.
The more premium, the easier.
Because there's moredistribution to be had.
Some of our clients have$5million,$10 million,$1 million
of premium.
It makes the deals a littleeasier to formulate because
(36:30):
there's more premium there towork with.
But a minimum of$250 and that40% loss ratio is what we're
looking for just
SPEAKER_00 (36:40):
as a pre-qual.
Incredible.
And what...
This is sort of a loaded topic,too.
What tax benefits, if any, arethere to setting up this kind of
program?
Because I could be incorrect onthis understanding.
I've understood that there aresome tax benefits as well to
doing something like this.
Obviously, premiums paid or atax write-off to the building.
Are there any other, or no, arethere any other tax benefits
(37:03):
that accrue to ownership or topeople that run these programs?
SPEAKER_01 (37:07):
Yeah.
For this question, it alldepends what kind of captive
we're going into.
There's group captives that aredomiciled in the Caribbean, in
the Caymans or Bermuda, wheretheir dividends are taxed going
back into the United States andthen into– we typically like a
trust to be set up for companiesthat are getting the dividends
(37:28):
returned from them.
But then you have some singleparent captives, which is you're
just in the captive all byyourself that are domiciled in
the United States, which have alittle more tax benefits because
they're not getting the doubletax on the premium or the
dividends being sent back fromthe Caribbean into the United
States.
So it all depends what type ofcaptive setup we have, but
(37:50):
you're still definitely gettingthe tax deduction on the premium
expense.
And then your mini insurancecompany, If the premium is under
2.85 million, we could takewhat's called an 831B tax
election where only theinvestment income for that new
insurance company is taxed.
(38:10):
The actual revenue that wentinto from your expense that
turned into revenue because it'sgoing into your captive, the
revenue is not taxed if it'sunder that 2.85 million
SPEAKER_00 (38:21):
mark for premium.
That's incredible.
So- Theoretically, just forround numbers, if you're
bringing in a million dollars ofpremium and that's revenue,
you're saying that milliondollars of premium is not taxed.
Only the investment income on itis taxed.
SPEAKER_01 (38:35):
If we take the A31B election, yes, the A31B election
has been scrutinized by the IRSa bit.
Because what happens isbusinesses or individuals set up
captives that are not actuallyinsuring for a true insurable
risk.
Right.
As
SPEAKER_00 (38:55):
a tax write-off.
SPEAKER_01 (38:56):
Exactly.
We're insuring for true risk.
We have actuaries.
We have captive managers.
We have true property riskbecause there's property that's
being insured.
There's general liability riskthat we're insuring for.
So we don't see those issues.
But with that tax election, theIRS does look at it as...
Okay, let's look a little moreinto it because you have this
(39:19):
asset now that just...
the individual expense, onepayment, put it into the
captive, and the revenue or thepremium is not over the 2.8
threshold, we're going to takethe election and not pay tax
SPEAKER_00 (39:33):
on it.
Incredible.
I mean, I didn't know that.
So that's a monster tax benefit.
But it sort of makes sense, too,because theoretically money
coming into your captive mayhave to go back out.
And it would be a difficultsituation to pay tax on money
coming in that you then have topay back out as losses.
Right,
SPEAKER_01 (39:48):
which creates underfunding.
SPEAKER_00 (39:50):
Totally.
So that makes a lot of sense.
Yeah, this is an incrediblypowerful program.
We are going to be working herewith Tony to try to set up our
own captive for the benefit ofour investors.
I think it's a huge opportunityto control a massive cost input
in this business.
I think it's a huge opportunity.
And I'm thrilled to have Tonyhere to talk through this
(40:11):
program.
I will provide his informationin the show notes and This
episode was so good that I saidin the beginning that it was
going to be premium only, and weare going to release it early to
the premium subscribers.
But I think I'm going to justalso include this in the
Timeless Investor Show becausepeople need to hear this.
This is a great story.
(40:32):
This is a really interestingprogram.
And these are the kind ofsolutions that astute operators
really need to think about.
So, Tony, thank you for being onwith us.
And it was a pleasure.
And I'll leave you all with theclassic podcast.
timeless investor sign off,which is think well, act wisely,
build something timeless.
(40:52):
We're doing this together.
We're sharing awesome Intel andreally grateful to Tony to be a
subscriber to our newsletter andto join us today.
Please reach out to him.
If you want to learn more aboutthis, we're going to do it
ourselves.
Thank you, Tony.
Thank you, Art.
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