Clay Ogden is the National Business Development Manager for SRA. Clay interacts with business owners, financial advisors, CPA firms, consulting firms, and health brokers to explain SRA’s risk management strategies.
Russ Alan Prince: Please describe SRA.
Clay Ogden: Do you ever lay awake at night wondering about the “what if” for your business? As we have seen over the last few years, there are many risks business owners take that traditional insurance does not cover. In fact, we have seen this concern repeat itself throughout history.
In the 1980s these same concerns were realized when the US experienced a hardening of the insurance market so significant it was called “The Liability Crisis.” During this time, insurance providers were raising premiums or canceling many businesses’ insurance altogether. This Liability Crisis drove congress to enact the McCarran-Ferguson Exemption, which limited dramatic surges in premiums, as well as Section 831(b) in the 1986 Tax Reform Act. This new section of the tax code gave power back to the business owner, providing an alternative self-insuring option using tax-deferred funds and allowing businesses to become self-reliant.
Much like the 401(k) tax code allows an employer to set aside tax-deferred dollars for retirement, the 831(b) tax code allows a business to set aside tax-deferred dollars for underinsured and/or uninsured risks. Previously, this tax code was exclusively enjoyed by Fortune 500 companies, but recently it has become much more widely accessible due to increased guidelines and competitive pricing. Just as a 401(k) requires third-party administration, so does an 831(b) plan.
SRA 831(b) Admin was founded on the belief that small and mid-size businesses are the lifeblood of the American economy. We administer 831(b) plans to ensure these types of companies can weather the storm by offering competitive pricing and ensuring compliance through stringent guidelines.
As we have seen in today’s ever-changing risk environment, it's important for a business to develop a comprehensive risk management program through an 831(b) plan. Any and all industries can benefit including:
- Entrepreneurs
- Property managers
- Dental and medical
- Manufacturers
- Self-storage
- Professional services
- Construction
- Retail
- Technology
- And many more…
Prince: What have you done for clients?
Ogden: COVID-19 was a hard lesson as insurance carriers denied business interruption claims citing indirect losses and language that limited coverage. While state and local governments labeled businesses as non-essential and forced them to close. Hindsight is 2020, and the 2020 pandemic made it clear that business owners must establish an 831(b) plan. SRA’s 831(b) plan not only addresses tangible asset risks through traditional insurance carriers but also addresses intangible asset risks.
There is no shortage of risks that business owners have identified over the years, which range from data breaches to key employee loss, credit default, supply chain interruptions, legal disputes, and many more.
An uptick in technology reliance on cloud-based software and third-party vendors to manage supply chain, sales, and data storage has raised concern over data breaches among many businesses. A catastrophic business interruption that insurance does not cover or comes with sub-limits and exclusions that hinder a full recovery. Using an 831(b) plan, businesses can set aside tax-deferred funds to recoup losses due to a data breach, third-party interruption, cyber scams, and more.
Business owners take on a significant amount of risk to run successful companies, but with an 831(b) risk mitigation strategy in place, they can rest easier at night knowing they have tools in place to support their business should unforeseen events occur.
Prince: What are the issues with 831(b) plans as far as the IRS is concerned?
Ogden: The advantages of an 831(b) plan are notable. In addition to the risk mitigation strategy, premiums paid to an 831(b) plan are tax-deductible business expenses and the premium revenue earned by the 831(b) can be excluded from taxable income. However, these tax benefits can quickly disappear if the IRS determines that the plan is abusive. One of the most important aspects of a compliant 831(b) plan that SRA requires is following the 4-Part Test which includes:
- Proper risk transfer: it must be clear that risk is contractually transferred to a third-party insurer
- Proper risk distribution: it must be clear that the plan utilizes the law of large numbers to disperse risk among many parties
- Fortuitous risk coverage: the plan must cover fortuitous risks and not ordinary business risks
- Act within the principles of insurance: the plan must operate similarly to how an ordinary for-profit insurance company would.
The 4-Part Test is built on the foundations of Rev. Ruling 2009-26 and relevant case law. Each part of the test is essential to successfully owning an 831(b) Plan and the ability to elect under the 831(b) Tax Code.
In addition to following the 4-Part Test, there are a number of red flags the IRS looks for when identifying abusive plans. It’s important that an 831(b) Plan avoids these pitfalls:
- Participating in an 831(b) only to lower your tax bill
- Vague coverage, unnecessary or duplication of existing coverage
- Premiums are expensive, inconsistently paid, and set to meet specific results
- No defined claims procedure to investigate and pay losses
- Inadequate reserves to pay claims
Unfortunately, not all 831(b) plan managers are created equal and IRS scrutiny has arisen when a captive manager does not ensure compliance.
Prince: What do you see as the future of 831(b) plans and SRA?
Ogden: Recent legislative changes and the failure of insurance surrounding COVID have proven 831(b) plans can be a lifeline to businesses during uncertain times. As these issues continue, insurance companies are not able or willing to carry all of the risks, requiring businesses to fend for themselves. Following COVID and considering the current liability crisis, we believed that owning an 831(b) Plan will become a normal business practice.
The future of 831(b) plans is bright. SRA expects more regulations to come from the Congress and guidelines to be published by the IRS, and with that comes clarity, improved fee structures, and more availability in the market. If you are an entrepreneur, bootstrapper, or already self-insuring certain risks, an 831(b) plan is a powerful way to efficiently manage your risk and defer funds during the good times to survive the bad.
RUSS ALAN PRINCE is the Executive Director of Private Wealth magazine (pw-mag.com) and Chief Content Officer for High-Net-Worth Genius (hnwgenius.com). He consults with family offices, the wealthy, fast-tracking entrepreneurs, and select professionals.
