By: Rubén A. Gely-Ortiz, AINS ARM CAMS | September 2024
Rubén A. Gely-Ortiz is the President of the International Insurers Consulting Group, the Editor-In-Chief of the Puerto Rico Financial Services Review (PRFSR), and a Board Member at the Puerto Rico International Insurers Association (PRIIA).
In September 2017, Hurricane Maria swept across Puerto Rico with devastating force, leaving behind a trail of destruction that would take years to fully assess and address. For many businesses on the island, the storm wasn’t just a natural disaster—it was a financial catastrophe. Insurance claims, meant to provide a lifeline in times of crisis, became a source of frustration and delay. Months passed, then years, and for some businesses, the promised relief never fully materialized.
This is the reality of living and working in a hurricane-prone area like Puerto Rico. The unpredictability of these natural events is compounded by the equally uncertain timeline of insurance payouts. After a major storm, insurance companies are inundated with claims, each one needing careful assessment before payments can be made. The sheer volume and complexity of these claims often result in significant delays, leaving businesses in a precarious position as they struggle to rebuild, reopen, and retain their workforce.
In the midst of this uncertainty, some businesses have found a way to protect themselves and their operations from the long waiting game that follows a disaster. They’ve done this by setting up captive insurance structures—a strategy that has proven invaluable in hurricane-prone regions like Puerto Rico.
THE STORY OF A SMALL MANUFACTURING BUSINESS
Consider the story of a small manufacturing business based in San Juan, Puerto Rico. The company had been in operation for over a decade, producing specialized components for the automotive industry. Their products were highly sought after, and they had a loyal customer base that extended across the Caribbean and into the mainland United States.
When Hurricane Maria hit, the company’s facilities suffered extensive damage. The roof of their main production building was torn off, leaving machinery and inventory exposed to the elements. Flooding caused further damage, rendering much of their equipment unusable. The company’s owners immediately filed an insurance claim, expecting that the coverage they had diligently maintained would soon provide the funds needed to begin repairs.
But weeks turned into months, and the insurance payout was nowhere in sight. The delay was due to the overwhelming number of claims filed after the hurricane, as well as the complexity of assessing the full extent of the damages. Meanwhile, the company was faced with mounting expenses. They needed to repair their facilities, replace damaged equipment, and cover the cost of business interruption. Every day that passed without the insurance money put them closer to financial ruin.
Fortunately, this business had taken a critical step before the hurricane season began—they had established a captive insurance company. This captive was designed specifically to cover gaps in their traditional insurance, such as deductibles, waiting periods, and exclusions. As soon as the hurricane hit, the captive was able to provide immediate funds to begin the recovery process. The company used this money to start repairs, secure temporary production facilities, and keep their employees on the payroll. While they still had to wait for the full insurance payout, the funds from their captive allowed them to stay afloat during those critical early months.
WHAT IS CAPTIVE INSURANCE?
A captive insurance company is a wholly-owned subsidiary that provides insurance to the parent company. Essentially, it allows a business to self-insure certain risks by setting aside funds in a dedicated entity. These funds can be used to pay claims immediately after a disaster, providing a crucial financial buffer while the business waits for traditional insurance payouts.
One of the key benefits of a captive insurance structure is the ability to tailor coverage to the specific needs of the business. For example, a company might use its captive to cover the high deductibles that often accompany property insurance policies in hurricane-prone areas. Captives can also be used to insure against risks that are typically excluded from traditional policies, such as certain types of flood damage or business interruption caused by supply chain disruptions.
In Puerto Rico, the international insurance center offers an attractive incentive for businesses to establish captives. The legislation allows companies to fund their captives with pre-tax dollars, effectively lowering the cost of setting aside these funds. Additionally, the net income of the captive, which includes both underwriting profits and investment gains, is taxed at a preferred rate of 4% when it exceeds $1,200,000. This makes the captive insurance structure not only a smart risk management tool but also a financially advantageous one.
WHY CAPTIVE INSURANCE IS CRUCIAL IN HURRICANE-PRONE AREAS
The experience of Hurricane Maria underscored the importance of having quick access to funds after a disaster. Traditional insurance, while essential, often comes with significant delays. The larger and more complex the claim, the longer it can take to settle. In the meantime, businesses are left to fend for themselves, struggling to cover immediate costs and keep their operations running.
In a hurricane-prone area like Puerto Rico, this delay can be particularly damaging. Hurricanes can cause widespread destruction, affecting entire regions at once. This not only increases the number of claims filed but also strains local resources, making the recovery process even slower. For businesses, the ability to tap into an emergency fund—one that is immediately accessible and designed specifically to cover gaps in traditional insurance—can make the difference between survival and closure.
Captive insurance provides this critical safety net. By setting up a captive, businesses can create a reserve that is ready to respond the moment disaster strikes. This reserve can be used to cover a wide range of expenses, from repairing physical damage to replacing lost inventory to paying employees during periods of business interruption. Because the captive is owned and controlled by the business itself, there is no need to wait for an external insurance company to process a claim. The funds are there, ready to be used when they are needed most.
THE FINANCIAL ADVANTAGES OF CAPTIVE INSURANCE
Beyond the immediate benefits in a crisis, captive insurance offers significant financial advantages.
The ability to fund a captive with pre-tax dollars means that businesses can set aside more money for future risks without increasing their taxable income. This makes it easier to build up a substantial reserve, one that can cover even the most severe disasters.
SOME BUSINESSES IN PUERTO RICO HAVE MITIGATED RISKS BY ESTABLISHING CAPTIVE INSURANCE STRUCTURES, PROVIDING IMMEDIATE FUNDS FOR RECOVERY, AND FILLING GAPS IN TRADITIONAL INSURANCE COVERAGE.
The tax benefits don’t stop there. Puerto Rico’s international insurance center has created a favorable environment for captives, with a tax rate of just 4% on net income over $1,200,000. This allows businesses to not only protect themselves from risk but also to potentially profit from their captive’s operations. Investment gains and underwriting profits generated by the captive are taxed at this low rate, making the captive not just a risk management tool but also a potentially profitable one.
PLANNING FOR THE FUTURE
As we look to the future, it’s clear that the risks posed by hurricanes and other natural disasters are not going away. In fact, with climate change, these events may become more frequent and more severe. For businesses operating in hurricane-prone areas like Puerto Rico, the question is not if another storm will come, but when.
By establishing a captive insurance structure, businesses can take control of their risk management strategy. They can create a financial buffer that is ready to respond immediately after a disaster, ensuring that they have the funds needed to keep their operations running. This not only protects the business itself but also the livelihoods of its employees and the broader community that depends on its success.
Hurricane Maria was a stark reminder of the importance of planning ahead. For those businesses that had already established captives, the storm was a test of their resilience—a test that they passed. For others, it was a wake-up call. As we prepare for the next hurricane season, now is the time to consider whether a captive insurance structure could be the key to weathering the storm.
In Puerto Rico, where the threat of hurricanes is always on the horizon, captive insurance isn’t just a smart financial move—it’s a necessity. The combination of immediate access to funds, tailored coverage, and financial advantages makes captives an essential part of any business’s disaster preparedness plan. With the right planning and the right tools, businesses can not only survive the next hurricane but emerge from it stronger than ever.
ABOUT THE AUTHOR: RUBÉN A. GELY-ORTIZ, AINS ARM CAMS
Rubén A. Gely-Ortiz is a visionary leader in the insurance industry, recognized as one of Captive International’s “40 under 40” for his exceptional contributions to the field. He is a strong advocate for Puerto Rico’s International Insurance Center and has played a pivotal role in revolutionizing captive insurance structures to meet the unique needs of Puerto Rican businesses.
With unparalleled expertise in Act 399, Rubén is a master in the formation and operation of international insurance entities in Puerto Rico. His deep understanding of risk management, compliance protocols, and the intricacies of both local and international insurance landscapes has positioned him as a leading authority in the industry.
In the specialized area of reinsurance, Rubén has made a significant impact by bridging the gap between primary insurers and reinsurers, ensuring efficient risk transfer and distribution. His strategic insight and unwavering dedication not only strengthen Puerto Rico’s insurance sector but also create meaningful opportunities for community impact.
For more information about this article feel free to contact Rubén A. Gely-Ortiz at ruben.gely@priia.org or browse the Puerto Rico International Insurers Association page https://priia.org
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