How RV Dealerships Can Improve Financial Agility with Reinsurance
This article was originally published in the RV Executive Today July 2024 issue.
Cash flow management is a major contributor to a business’s financial health and agility. Many RV dealers are using dealer-owned reinsurance companies to achieve long-term financial goals and expand their cash flow capabilities.
With the increase in the number of administrators and agents who focus on products exclusively for automotive and RV dealers, the set-up and maintenance of reinsurance companies has become less burdensome for dealers making it a cash flow management tool worthy of consideration.
Explore the potential cash flow outcomes of having a reinsurance company in your finance toolkit and how this opportunity may benefit your business.
Dealer-Owned Reinsurance Company Basics
A reinsurance company assumes risk from another insurance company. While there are many different types and forms of reinsurance contracts, a dealer-owned reinsurance company involves the reinsurer assuming the risk of claims related to finance and insurance products that are sold by a dealership to end consumers such as vehicle service contracts and guaranteed asset protection policies.
The original insurer transfers premium reserves less fees to the reinsurance company which is owned by the dealer or other beneficiaries. The reinsurance company’s cash flow comes from underwriting profits as well as income from investing the premiums.
As with any company, there are risks in reinsurance companies and no cash flow is guaranteed.
Potential Cash Flow Benefits
The most straight forward cash flow benefit resulting from a dealer-owned reinsurance company is the deferral of income for federal income tax purposes. The income associated with the finance and insurance products is deferred until such time as the income from the reinsurance company is distributed either through normal distributions or a liquidating distribution. Income from the investment earnings on the accumulated reserves remains taxable under an Internal Revenue Code Section 831(b) structure.
The benefits of this deferral are two-fold:
- The tax implications are deferred until such time as the owners choose to make distributions
- The income is taxed at lower capital gains or qualified dividend tax rates.
As there’s no obligation to make distributions from the reinsurance company, the ability to control cash flow timing is possible.
For instance, many RV dealers are considering succession planning. One possibility is for the next generation to purchase the operating business combined with a purchase option on the real estate. If a reinsurance company is setup at the time the operating dealership is purchased by the successor, the reinsurance profits can be a source of funding for the later real estate purchase.
Additionally, many can borrow against the earned and unearned premiums in the reinsurance company. This unique source of funding can be used for acquisitions, inventory, capital expenditures, etc.
Often the reinsurance company will have a different ownership structure from that of the operating dealership. By having the owners of the reinsurance company be the dealer’s beneficiaries or key management, the reinsurance structure can be used to move cash flow to the next generation or motivate key managers without giving up ownership in the operating dealership.
Relevant IRS Regulations
While there are various forms of reinsurance companies, dealer-owned reinsurance companies are commonly set up to take advantage of regulations for small non-life insurance companies, also known as micro-captive insurance companies.
Often these companies are set up in foreign countries and make a Section 831(b) election to be taxed as a US insurance company. There are limitations on the amount of premium income that a micro-captive company can have annually. The limitation is indexed for inflation each year. For 2024, the premium limit is $2.8 million.
The IRS has mandated disclosure requirements for micro-captive insurance companies due to the substantial tax benefits these structures can have along with potential for abuse. The penalties for noncompliance with the disclosure requirements are significant—consulting with a tax professional is suggested.
Looking Forward
Dealers will need to work with their legal counsel, accountants and investment advisors as reinsurance companies must be structured appropriately and meet regulatory and financial conditions. When considering a reinsurance position potential risks and your individual financial situation and goals should be evaluated.
However, when structured appropriately, they may be another way for dealers to achieve their long-term financial goals.
We’re Here to Help
To learn more about how dealer owned reinsurance companies can benefit your RV business, contact your Moss Adams professional.