Why You Should Increase Your Deductible, or Even Form Your Own Captive

Insurance policies contain the equivalent to a 40 percent tax in their premium. This tax provides profit and expenses to the insurance company and makes up roughly 40 percent of the entire premium charged. Insureds take a deductible to reduce the premium charge and lower the tax otherwise paid as part of those premiums. Better to pay for an uncertain claim event than a certain tax included in the premium immediately. This is the reason for the old adage, “Never trade dollars with an insurance company.” The exchange rate is roughly 40 percent, and that’s not a good deal for you.


A deductible is an example of unfunded self-insurance that comes due when or if a claim happens and the deductible amount becomes due. You see this with automobile comprehensive and collision coverage. They have deductibles. A deductible simply means you pay before the insurance company pays when a covered loss occurs.

Under our water treatment program, a deductible only applies if we have to pay or indemnify another for loss. Our deductible only applies to indemnity, not defense. That relieves you of the burden of paying a deductible for defense every time a claim or suit is filed. You only pay if you are found negligent and an award is made against you or if the insurance company chooses to settle. Your deductible would apply to the settlement only.

Many companies apply the deductible against defense and indemnity. Some carriers may even use your deductible at the standard legal rate for their attorney instead of including it on any discounted rate they may have negotiated with counsel. Your obligation under the deductible is not included in that agreement.  Here they simply burn through your deductible at the billed not the negotiated rate then internally, they may reduce what they pay at the network rate thus lowering their costs.

An example shows how this practice may work. A legal bill for services is $10,000, but the insurance company has a panel counsel arrangement that limits the charge to $4,000. You are billed the $5,000 deductible and pay the insurance company who has only paid the attorney $4,000. Remember the billed rate was $10,000 and you are responsible for repayment at that rate.


A captive is fully funded self-insurance. You use the captive you own to fund your own risk of loss. By having the captive you pay yourself the 40 percent tax otherwise lost in a traditional insurance premium and you are creating an insurance company with all the tax breaks a regular insurance company enjoys. You also retain the business expense deduction treatment for premiums you pay into the captive. A captive turns a business expense into a financial asset managed for profit.

This is why captives are popular for insureds that have the tolerance for assuming insurance risk and the capital required to do so. For smaller businesses, effective use of deductibles will lower cost and improve effectiveness of the insurance purchased.

About Watercolor Management

WaterColor Management has insured the water industry for over 30 years.  Our policies include unlimited defense cost coverage in the event of a lawsuit against you. Call us at (256) 260-0412 or email info@watercolormanagement.com for a quick quote for your Water Business Professional, Products/Completed operations, Pollution and General Liability Insurance.