SPEAKER_00: 0:00

Hello, everybody. Welcome to another episode of the Timeless Investor Show Premium for our paid subscribers to the Timeless Investor Newsletter. I'm incredibly excited to be here. This is just full disclosure for everyone. This is my first actual interview with someone. We obviously run a podcast show and I do a lot of solo episodes. So Tony here is going to be our test subject. And brought directly to you guys to hear some incredible intel and really exciting stuff that I just learned yesterday. Tony is a subscriber to the Timeless Investor Show. So we are building a really cool community here. He actually reached out to me and was interested in what we were doing. And we had this incredible conversation, which... Literally, we talked yesterday and I was like, I've got to get this going ASAP for everyone. This is incredible intel, really valuable insights, something I've been thinking about a lot. So I want to introduce you guys to Tony DeFede with Union Risk. His firm specializes in setting up captive insurance programs for operators of real estate and any other business all across the country. This is a strategy that... The big boys have been using for a long time to control insurance costs and premiums. And Tony's team makes it available for everybody, right? I mean, you still have to have a fairly large portfolio and quite a bit of stuff. But just quickly before I let Tony take off, I just wanted to set the framework here. So most of you are real estate investors or business owners and everyone is sort of dealing with a really brutal situation. insurance premium environment. And we've talked about it. We wrote pieces on the hard cycle of insurance over time. And the insurance industry is this incredibly cyclical beast, right? And we're in a hard cycle right now. And I'm really looking forward to hearing Tony's analyses of kind of what's going on. But for ourselves, we've seen insurance premiums go up 2X, 3X. All the major carriers are exiting. American Family was a huge insurance company we worked with all across the Pacific Northwest, and they completely dumped multifamily risk, and it's caused premiums to rise everywhere. State Farm is exiting California. It's a really bearish time for insurance, and this is the time, and this is why I'm really excited about this, and we're going to try to do this with the Lombard Equities portfolio and other partners we have in this market. This is the time for creative, unique solutions, and Tony has got it. So, Tony... Please introduce yourself and tell us your analyses of the insurance market, and then let's dive into captives.

SPEAKER_01: 2:36

Sure. All right. Well, thank you for having me. I am Tony DeFede, the partner and the chief risk officer at Union Risk Services. Union Risk is a captive insurance specialty brokerage located in New Jersey, specializing in captive insurance for companies doing between$5 million a year in revenue and close to a billion a year in revenue and everywhere. in between. With where the insurance market is right now, as I'm sure everyone listening knows this, we are in the hardest insurance market from what I have seen and from what I've heard from industry veterans and Mohegans in the last 50 to 100 years without a doubt. These last five years in insurance have been the toughest time for the insurance industry. And what does that mean? That means for the payers of insurance, which are people like Ari and the people listening to this podcast right now, rates are doubling, tripling, quadrupling in some cases. Now, why is this happening? Catastrophes have one thing to do with that. Over the last five to seven years, over$50 billion in catastrophe costs costs have been paid out by insurance companies or are set to be paid out by insurance companies, which they have to prepare for. So that's one reason why no matter if you have a car for car insurance or homeowner's insurance, or if you're like Ari and own a ton of real estate and many doors, your insurance costs are going up no matter what, because the insurance companies themselves are in a position now where they have to fund for these massive claims which have occurred in the past five to seven years. And they are trying to make money on top of that. And the only way to do that is to set the insurance increases that we've been seeing for the longest time. Prior to the hard market was probably the best insurance market in history. And what leads to a great insurance market? It's a few things. The level of catastrophes were a little less. And all you need is a little arbitrage there for insurance companies to make the money they need to make from the investment income, which is something we utilize with captive insurance. The investment income for these insurance companies is how they make all their money. Even if their loss ratios are 100%, meaning any premium that's been paid in for a policy gets paid back out for expenses, they are still making money on that insurance premium as it sits there, which is what we do with captive insurance. So when you have a soft market like we had, the liquidity was plenty, the losses were a little more contained Right. Certain premium numbers.

SPEAKER_00: 5:41

And the timing, it's interesting too, like the timing of the soft cycle and insurance really coincided with incredibly low interest rates as well, which is sort of, which we talk about, you know, real estate isn't a bear market today. And one of the factors that's crushing real estate is interest rates, right? Interest rates have doubled or tripled in many cases. And a lot of poorly underwritten deals are really underperforming now. But the thing that I, I mean, we talk about interest rate cycles a lot. in real estate because it's incredibly critical to the valuation of real estate. But the input costs into running properties have risen dramatically. Payroll is up, right? I mean, all driven by inflation. But the thing that is really torpedoing a lot of deals is that we... So like on top of an interest rate increase, we've also have this environment where premiums are up two to three X. And no one... When you underwrite a real estate deal, it's like, you just estimate 3%, 4%, 2%, something in that range, annual expense increases. I don't think anybody, anybody in the entire real estate business forecast 30% to 40% annual increases on insurance premium, which is kind of what we're seeing. Unless you have the highest quality asset that is brand new, everybody else is getting crushed, which happens to be most of the market. One of the things I realized when researching this more is the It seems like one of the factors that's really crushing premiums is the reinsurance market has been really heavily hit. So reinsurers, from my understanding, are sort of pulling back from underwriting risk. And that is also causing a downstream effect, right? Because these insurance... And I think for edification of the audience too, how does that work? The mainline carriers offset the risk to reinsurance, but if reinsurance starts pulling out... I think Swiss Re was saying they've had some massive amount of claims and losses due to natural catastrophes. Also, the social unrest during COVID, like big buildings burning down or being severely damaged. What effect have you seen? I mean, that is obviously a huge impact. Is that something you're seeing?

SPEAKER_01: 7:46

Without a doubt. Just for everyone who's listening right now, reinsurance is insurance for an insurance company. So when an insurance carrier is going to write specific classes of business, in this case, let's say real estate for Ari's listeners, they are actually getting a sign-off approval from their reinsurance company. But what's been happening because of these massive claims we've been seeing for the last five to seven years, the reinsurance companies have had to pay claims or take on parts of claims for their insurance company clients. So when this happens now, a reinsurance company sits back after year end of 2024 and sees, oh, we are actually at a minus of 15% across our reinsurance portfolio. So we're actually losing money on insuring our insurance companies. How do we stop this? One way to do that is to raise the reinsurance costs on insurance companies, which in turn gets put onto the consumer. In this case- RE and Lombard equities. And another way they do this is by tightening their risk appetite. When you have insurance companies that have tightened their risk appetite like they have for the last five to seven years, there are just not as many players in the marketplace as there were in 2015, 2016, 2017. So all of this is the perfect storm for the hardest insurance market in history.

SPEAKER_00: 9:15

Yeah. Well, that's a critical piece. And I feel like a lot of folks don't fully understand or respect the impact of reinsurance on insurance, right? Because insurance companies aren't taking all the risk, like you said. And their ability to offer their premiums is because they offset some risk. And if that risk offsetting gets pricey, that flows down to us. The other thing, I'm kind of curious your perspective on this. Obviously, natural disasters have been rising. um you know the the 10-year 100-year storm is now like in every other year occurrence right florida hurricanes are a really good example we've had a dramatic increase in really adverse weather events california with the wildfires i would argue it's also a climate change related difference right i mean i like i look at it from the pacific northwest i live in oregon oregon's temperature bands have risen over the last 10 years oregon is actually I would say a net beneficiary of climate change because the weather has been getting warmer and nicer. It's almost like the new California. And I'm from California. When I go back to California, it's hotter, right? It's hotter and it's drier. And it's like that. So the question that I wonder is when big weather events happen in Florida or California, or you have a Texas like major freeze, right? Texas is another market where insurance is really, really difficult. That has a knock on Ram. So like, A lot of folks will be like, well, I invest in X market where we don't have weather-related events and other problems. But they're the same risk pools that are covering Florida as are covering... I don't know. I can't think of a non-risky market. But somewhere in the Midwest where they don't have tornadoes and there's no big weather-related problems. But their premiums, I presume, are also rising because those insurance companies are trying to offset their risk in Florida and California and other markets. I mean, is that accurate to say... Natural weather patterns in parts of the globe that have no impact on your market still have an impact on your premiums because they have to offset the cost, right?

SPEAKER_01: 11:17

Right. That's exactly what's happening is you have State Farm in California, let's say, who just got blown out of the water because of the wildfires and other natural disasters. Now we have State Farm in New York, who is all of a sudden non-renewing auto liability risk for transportation companies because that risk is in New York coupled with the risk in California is just not worth the overall risk to a company like State Farm. So what happens now? A major insurance player like State Farm pulls out of New York for transportation companies. Now all of a sudden, transportation companies in New York, instead of there being four major players, there might only be three or two. What happens then? Because they've also taken on losses, premiums just continue to rise across the board. So there is a correlation even with different insurance companies, with their offerings being affected by other carriers

SPEAKER_00: 12:13

as well. Right. Well, it's going to be interesting too. For those of the listeners that are investors in California or homeowners in California, one of the things I've been watching pretty closely is California– has been very successful at artificially suppressing insurance premiums in their market. And that is the reason most of these carriers are exiting California because they're not allowed to raise premiums the level they want to raise premiums. And for example, my home in Portland, I pay about$1,000 a year for my homeowner's insurance. And I have many, obviously from the Bay Area, many friends who pay$6,000 to$7,000 a year right now for their homeowner's premium. And that is a suppressed premium. rate in california because the california insurance commission won't allow them to raise rates so this is giant game of chicken what's this is a total tangent but what's really alarming about that if you're a californian or any other market that has an artificially suppressed premium environment is eventually california i mean california can't play that game forever they need to have insurers and california can't underwrite all the risks themselves What I think will happen is they'll have to capitulate. And then if they let premiums float to the level they actually have to be in market, it's going to be a double or tripling of homeowners insurance premiums, which has a serious knock-on effect. If you think about your ability to afford a home in California, if the premium triples for homeowners insurance, what does that do to home values in California? And actually, it's even more It's even more nefarious because California's Prop 13 controls property tax rates, right? But you reset your property tax rate based on the purchase price of the home. So California is in a really big pickle right now because if they let premiums float, home prices tank and their property tax revenue will start to drop. People will be reassessing property tax rates, all this kind of stuff. So it's a really dicey situation, you know, driven by some government policy involvement in the business, which one could argue is sort of manipulative of the market and creates a distortionary effect on the market, which now we're seeing in California. And we're seeing it. We own assets in California. The last piece on the insurance market, I just want to get your two cents on, Tony, is the advent of artificial intelligence and the ability for insurers to better understand their risk with ai that's one theme i've been hearing about quite a bit from industry contacts is insurers are realizing i know this is another argument for why rates are rising they are realizing they were underwriting risk but mispricing the risk and with ai and kind of big data and looking at stuff they've started to realize so like crime scores an AI overlay of analyzing neighborhoods and crime scores has started to become a huge impact too on insurance premiums, which I imagine is only moving premiums up

SPEAKER_01: 15:09

generally. Right, because what's happening and we now use AI every single day at Union Risk and so do our insurance carrier partners or captive manager partners. AI is allowing an analytical portion of risk to be looked at that was previously never seen before or cannot be calculated fast enough by five people on a traveler's insurance company team or 10 people on a AIG insurance company team, where now we're getting real time data at the snap of a finger, basically, from these AI models that not only show you the data in real time, but can now give you a very good prediction of what might happen in the next three, five, 10 years with an insurance policy, with the amount of premium that's being paid into it, and what's the risk for the insurance company and the reinsurance companies to be truly profitable on this insurance policy that they just sold. Because the problem that's happening is a homeowner's policy in California that for easy numbers, we sell for$10,000 a year. If the loss on that is 15,000, let's say for that policy year, the insurance company and the reinsurer are underwater on that policy. So how do we go and recuperate that 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 pull out of certain areas where they just can't get to premium pricing that one, makes sense for them, but two, consumers could actually afford to buy because affordability is going to start becoming a problem if these insurance companies raise the rates to where they should be based on the historical risk data.

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 stick into it a little bit longer. What do you think, this is a loaded question, but what do you think the next three to five years looks like in the insurance market? What do you think is the necessary conditions for captives insurance to soften and us to move out of the hard cycle back into the soft cycle for insurance? Because inevitably it will happen, right? We have 100 plus years of history to say it. And I wrote a piece on the timeless investor, the hard cycle of insurance, looking at 100 years of insurance history. And one thing's for sure, it is cyclical. It moves back and forth. But what do you think are the conditions necessary for premiums to start softening major carriers? Because in my... Tell me if you think this is wrong, but in my view... you know, we had buildings insured for$40,000 a year in premium and that American family insurance and our new insurance policy is 140,000 a year, right? Very lucrative. That building has never had a claim. 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 profitable for that insurer. So then to me, it's like at some point, the major carriers, the frontline tier one carriers will say, that's a really profitable space. Let's go back into it. But what do you think is the condition and timing necessary for that cyclical change to kind of come back in? So two things have to

SPEAKER_01: 18:32

happen at scale. The first is these are catastrophic events that are happening. They need to basically take a year or two off, hopefully. Okay. so that the losses are not the astronomical figures that we've been seeing for the last five to seven years. With these losses happening the way that they are, the insurance companies are so underwater in terms of the premiums they were allocating for to pay these claims out that, again, they have no choice but to raise rates across the board. So even for your properties that you've seen a 3X on that, oh, this insurance policy itself for Ari is, we're in the green 100%, plus the investment income we're making off the policy. But what you don't see is American Family, the rest of their portfolio, they might have taken on loss ratios of more than 100%. Because that's also what a lot of people don't understand about the insurance companies. They're expecting loss ratios between 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 is still 10%. Plus, as that premium is sitting there, they're gaining another, depending where they're invested, between 5% and 10% on the money that's sitting. So when you do this at scale for billions and billions of dollars, which is what most of these insurance companies are capitalized at, it could be very lucrative. The problem is, When you cross over that 95% loss ratio threshold and you get closer to 100 where the premiums are just out of whack, that's the issue that's happening. So if we can mitigate or say a prayer or do a rain dance to whoever we might do it to, that's going to be the best way to have premiums that become more affordable and get back into that soft market. And secondly would be interest rates. If those drop back down to, you know, two and a half, two and a quarter, 2% potentially, it'll allow more players to gain the liquidity, take the loans out that they need to recapitalize and get back into the

SPEAKER_00: 20:45

marketplace. That's an interesting perspective because I would think higher rates means that insurers are earning more money on their float. So I guess it would go both ways, 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, probably majority, yield type very conservative instruments and maybe some smattering of stocks i would think that their investing profit is higher as a result of higher interest rates but

SPEAKER_01: 21:15

so to that point yes okay yeah new players coming in though where hey we maybe we'll spin off a portion of our insurance company to just go after this type of risk or a startup insurance carrier comes into the fold now they need to be able to raise the capital and get money on a cheaper basis to go and make these steps to become insurance companies and to offer rates that, hey, maybe we're 30% less than the market because we've only been around two years and we haven't taken on catastrophic losses. It allows us to be a player in the space from a product offering standpoint.

SPEAKER_00: 21:55

Okay, incredible. Yeah, I mean, it's an interesting time. So- My thesis and your reach out was very fortuitous and hence my excitement to have you on here and my excitement to talk to you yesterday was it feels to me like as I've gotten deeper in the real estate business, I've realized controlling the cost inputs is the only real way to win in this business, right? And so... And everything, right? And just to digress briefly, like controlling property management is controlling a cost input, controlling the contracting arm of your business, controlling that cost input, even like as basic as controlling the laundry service to your asset. Like we've realized recently that we're giving away an enormous amount of revenue to laundry servicing companies that we could control the cost input, control the maintenance spend, control it. I don't think people usually think of insurance as something they can control. And it's a little bit, there's an aspect of it that's not controllable, but the idea of captives was really interesting to me because I look at our portfolio and we have no claims, right? We've had none, but our premiums have gone up three to four X in many cases. And it feels like we're getting lumped in with losses elsewhere. And like maybe our buildings are just getting unfairly penalized or maybe they're fairly penalized or they're getting unfairly penalized by the fact that we're in a hard insurance cycle. It's probably a mix of all of those things. But the captive model was really interesting and was something I had looked into before you reached out. But why don't we pivot now and just talk a bit about your primary business and maybe just for the audience, a quick recap on what is a captive insurance company?

SPEAKER_01: 23:31

Sure. So a captive insurance company is a mini insurance company that a business or real estate owner creates for their insurance portfolio. So what we're doing is we're taking... The same method that Warren Buffett and Berkshire Hathaway have used, that AIG has used, that Zurich has used for well over 100 years. And we're scaling that down to size for small, medium, and middle market types of businesses. So what we're doing is instead of paying the insurance expense to the insurance company and getting no benefit for that, no matter what you do, no matter how good the claims performance is, we are taking our clients out of the traditional market, and creating a captive insurance company for them. With this captive insurance company, they are partnering with an A-rated insurance carrier, whether that be AIG, Berkshire, Zurich, whoever it is, to formulate this mini insurance company where they now, being our captive, gain the benefit of good claims performance, of low loss ratios. So after a few years of building the premium into there, the captive actually sends dividends now back to the client or the real estate owner. So we're taking the premium that we already paid, we're moving that over into a separate bucket, so we're still paying it out, but this new bucket is now the captive insurance company. So instead of having a full expense on day one, we have that same expense that's still tax deductible, but we're putting that into a brand new asset. So we're creating a new asset for our clients on day one of their new captive insurance policy. The goal is, like you've seen, and like many of the listeners have seen, take our clients out of the traditional market so they are not affected and don't have the crazy rate increases that have been happening throughout the

SPEAKER_00: 25:30

insurance industry. Because you have more control. You have some more control of the insurance product. And there's economic benefits, of course, if you control the captive that's actually offering the risk underwriting to your properties. One question I want to double click on. You mentioned we're taking what Berkshire, what AIG, what Zurich have done and bringing it down to the... Can you just describe? Because I don't know what that means exactly. Can you describe what are they doing that we are replicating here? Because in my mind, I just imagined they were just regular insurance companies. I didn't realize there was something they're doing unique that we're translating to the lower market.

SPEAKER_01: 26:09

So I've mentioned investment income a few different times on this call. So what happens is as our premium is sitting there, it's gaining that investment income interest year over year, which compounds. So average in the captive insurance basis is 5%. Let's say the premium each year for simple numbers is 500,000. We're paying that premium in every single year. But as it's sitting there, Throughout four or five years, it's still gaining that 5% in each of those different policy years. So at scale, that is how Warren Buffett specifically with Berkshire, every insurance company does it, but he did it in a way where, of course, for Department of Insurance purposes, you have to have a certain amount of that investment income completely stabilized and in safe hands. But the excess of that, he was able to go and invest in Apple or Coca-Cola, whatever, he was doing with it. So we're taking that exact model and just scaling it down to size for our captive products.

SPEAKER_00: 27:12

Got it. Very interesting. So when we talked yesterday, you mentioned, because I was kind of asking like, well, how are we reducing the premiums? And you had mentioned that you, on average, people see a 20, 20% roughly reduction in premium by going to captive route. Plus you have control of the asset. Plus you're earning investment income on the premium that's coming into the pot. Can you, Just walk through the mechanics of like, you set it up, money comes into it. And this was a question too we had yesterday, which was, how are lenders okay with this? And you had a really insightful answer to the way, because my immediate response was, well, if I set up a captive and we have, I don't know, 400,000 of premium a year we pay, we don't have a huge pool of float to protect ourselves. And is my lender really going to be okay with that? And so I thought you had a really insightful answer to that. So if you don't mind just diving into some of those mechanics, that'll be amazing for the listeners. Sure.

SPEAKER_01: 28:06

So from the lender standpoint, what we're doing is we're partnering with these A-rated, highly financial rated insurance companies. Those insurance companies, we are using the policies of their actual paper. So on a captive insurance policy, it won't say Ari's Insurance Company, LLC. It'll say AIG as the actual insurance company, which we've never seen a lender, especially in real estate, have an issue when we are presenting AIG paper or Zurich, whoever it might be. Secondly, in terms of how we're keeping those rates down or how rates decrease from the start, we are now only rating the insurance policy for Ari based on Ari's own loss ratios from the last five years. So because we are taking this company out of the traditional insurance market, it's now in its own bubble where the actuaries will look for the last five years of premiums and the last five years of claims and say, oh, Ari's actually running at a 95% profit each year. He doesn't actually need a 3X on his insurance. It could be 20% or 30% lower, and there's still more than enough premium there to fund for any claims that might happen. And to build off funding on claims, we partner with one of these A-rated carriers because they will pay the majority of each claim that typically happens. So Ari's company might take on the first$150,000 of every claim. But when it gets past$150,000, the insurance carrier comes in and they provide the rest of the payment 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 claims are under that$150,000 number. So from the insurance carrier's perspective, they no longer have to fund any risk except for like a catastrophic situation, basically. Is that true? Would you say like... What is it, the 80-20 rule? Like 80% of your losses are under or more. Actually, do you have a number on that or do you know roughly? Do most claims fall under that number? So for our

SPEAKER_01: 30:28

captive programs, if we take five years and we look at the last five years of a captive, four years run great and you might have one year that has the potential of having that excess claim. So we're looking at a four out of five good performance year scale. dealing with any of the captives that we have in place right now. And because captive insurance you have to qualify for in terms of safety, sure, catastrophic events we can't quantify for, we don't know what might happen. But because the safety protocols are so stringent to get into the captive, all of our captive clients and companies that go into captives have their standards at such a level where they're avoiding most of the typical risk that companies see in the traditional insurance market because the standard to get into the traditional market are a hundred times less than what they are to get into a captive.

SPEAKER_00: 31:26

Okay. What do you mean by that? When you say that, like, does that mean that they're more stringent on the assets that they'll insure through a captive? When you say that, like, I just want 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 or fakes a slip and fall, how do we defend that? How will we know that's happening? Right. If, you know, are Ari's sidewalks all paved and nicely done? If two of those things aren't happening, that company, and I'm just using two examples, the company that's trying to get into a captive might not have a chance of getting in until they make certain improvements. So the captive is making the standard improvements for the insured for the client to get into the captive more difficult than it is in the traditional market where most of the time even if there's an inspection that has to be done someone comes takes three pictures and and leaves whereas with captives we are trying to secure our risk as much as possible

SPEAKER_00: 32:29

understood so you mentioned before that insurance companies anticipated 80 to 90 percent loss generally on their operations is that Is that roughly how captives perform as well in your experience when you look at your portfolio of captive insurance companies?

SPEAKER_01: 32:45

No. The losses across captives are probably anywhere from 25% to 40%, let's say. These businesses are so much higher standard than businesses that are still in the traditional market. That's really the reason.

SPEAKER_00: 33:06

Right. For real estate specifically, how does that manifest itself? Is it difficult to insure through a captive product older buildings? Because that's really where the difficulty has been with insurance. If you have a Class A new build, it's easy to find insurance. All the main carriers will still cover it. The question, I guess, is can you set up a captive with older vintage buildings with more... more challenging systems issues, right? That are like, there is no market for those assets right now. To me, that's the question is like, is that something one can do in this business? Or is the captive program really meant for someone that owns a thousand class A units that are brand new and they're just trying to control their own premium costs? Or is

SPEAKER_01: 33:51

it both? So the minimum premium we look at for a captive is somewhere in the$250,000 range. And for the real estate captives we do, that includes property and general liability. insurance. The beauty of captives, and you mentioned the age of the buildings just now, we are only looking at the claims data to say this makes sense or this does not make sense for a captive. If Ari's been performing at a 70% loss ratio over the last five years, the captive manager might say, this might not make sense right now. Let's try to get some safety standards in place and make the loss ratio more palatable for from a profit perspective. But if that loss ratio is close to or under 40%, then there's real profit there. Or zero. Or zero. Or zero. Knocking on wood. Knocking on wood. Knock on wood indeed. That good Oregon wood you have out there. Yeah, exactly. That's what we're looking for is anywhere under 40. It could be a little more if the scale's there for the size of the business we're looking at. But that's what we like to see. So the judgment is only off of the claims data itself.

SPEAKER_00: 35:02

Okay, amazing. Yeah, look, I think I've had a theory that as this market gets more crazy and difficult, that people were going to start looking for unique and alternative solutions to solve this problem and to control the cost input. And I think, honestly, I think this is a genius approach and something I've been really interested in. What... How do people, I'm going to put your information in the show notes so people will be able to reach out to you. But what would you say is like the classic business owner scenario? Because we have listeners that are just business owners as well, right? They're not all real estate folks. What would you say is the ideal situation where you're like, we can help you. We can do this for you. What do you think is the right client for you?

SPEAKER_01: 35:49

Sure. Ideally, as long as the business, and whether that's a manufacturer, construction company, transportation company, a real estate company, as long as they're paying a minimum of$250,000 a year in premium, and they have good claims performance, which is somewhere in that below 40% range, if you just divide your claims by your premium, that's the loss ratio that we're looking for, we can start conversations with those businesses. The more premium, the easier. Because there's more distribution to be had. Some of our clients have$5 million,$10 million,$1 million of premium. It makes the deals a little easier to formulate because there's more premium there to work with. But a minimum of$250 and that 40% 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, are there to setting up this kind of program? Because I could be incorrect on this understanding. I've understood that there are some tax benefits as well to doing something like this. Obviously, premiums paid or a tax write-off to the building. Are there any other, or no, are there any other tax benefits that accrue to ownership or to people that run these programs?

SPEAKER_01: 37:07

Yeah. For this question, it all depends what kind of captive we're going into. There's group captives that are domiciled in the Caribbean, in the Caymans or Bermuda, where their dividends are taxed going back into the United States and then into– we typically like a trust to be set up for companies that are getting the dividends returned from them. But then you have some single parent captives, which is you're just in the captive all by yourself that are domiciled in the United States, which have a little more tax benefits because they're not getting the double tax on the premium or the dividends being sent back from the Caribbean into the United States. So it all depends what type of captive setup we have, but you're still definitely getting the tax deduction on the premium expense. And then your mini insurance company, If the premium is under 2.85 million, we could take what's called an 831B tax election where only the investment income for that new insurance company is taxed. The actual revenue that went into from your expense that turned into revenue because it's going into your captive, the revenue is not taxed if it's under that 2.85 million

SPEAKER_00: 38:21

mark for premium. That's incredible. So- Theoretically, just for round numbers, if you're bringing in a million dollars of premium and that's revenue, you're saying that million dollars of premium is not taxed. Only the investment income on it is taxed.

SPEAKER_01: 38:35

If we take the A31B election, yes, the A31B election has been scrutinized by the IRS a bit. Because what happens is businesses or individuals set up captives that are not actually insuring 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 risk because there's property that's being insured. There's general liability risk that we're insuring for. So we don't see those issues. But with that tax election, the IRS does look at it as... Okay, let's look a little more into it because you have this asset now that just... the individual expense, one payment, put it into the captive, and the revenue or the premium is not over the 2.8 threshold, we're going to take the 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 may have to go back out. And it would be a difficult situation to pay tax on money coming in that you then have to pay 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 incredibly powerful program. We are going to be working here with Tony to try to set up our own captive for the benefit of our investors. I think it's a huge opportunity to control a massive cost input in this business. I think it's a huge opportunity. And I'm thrilled to have Tony here to talk through this program. I will provide his information in the show notes and This episode was so good that I said in the beginning that it was going to be premium only, and we are going to release it early to the premium subscribers. But I think I'm going to just also include this in the Timeless Investor Show because people need to hear this. This is a great story. This is a really interesting program. And these are the kind of solutions that astute operators really need to think about. So, Tony, thank you for being on with us. And it was a pleasure. And I'll leave you all with the classic podcast. timeless investor sign off, which is think well, act wisely, build something timeless. We're doing this together. We're sharing awesome Intel and really grateful to Tony to be a subscriber to our newsletter and to join us today. Please reach out to him. If you want to learn more about this, we're going to do it ourselves. Thank you, Tony. Thank you, Art.