The COVID-19 pandemic highlighted the fragility of the business landscape in ways no one could have expected. With most people confined to their homes and dealing with social distancing rules, businesses had to adopt new ways to make money or risk closing their doors. One of our clients owned a dental clinic in a university town, which depended on students coming in its doors. When the university transitioned to online classes and most students went home, that income disappeared. However, this business had an advisor who understood risk mitigation efforts and encouraged them to use an 831(b) plan, thus allowing the clinic to keep its doors open and pay its employees while waiting out the storm.
An 831(b) plan allows businesses to set aside tax-deferred dollars for uninsured risks, resulting in companies creating their own form of self-insurance. Most often, these are used for emerging risks companies cannot plan for ahead of time. These are things not covered by traditional insurance.
In fact, traditional insurance only covers what companies refer to as pure risks, which are types of risks that are beyond human control. These risks may result in some form of loss, or they may not; however, there is zero possibility of a financial gain. These risks, also known as event risks, may include fire or death. They cannot be predicted beyond a person’s control.
However, emerging risks are categorized separately, leaving business owners open to major loss. Some may refer to this as a “loophole” in a policy holder’s insurance coverage, allowing insurance companies to deny the insured business or individual coverage for unexpected losses.
There are often three categories of emerging risks advisors should know about:
- A new risk in a known context: These are risks that emerge in the external environment and impact the organization’s existing activities.
- A known risk in a new context: In the scenario of a risk already known but has evolved, the management of said risk may need to change.
- A new risk in a new context: These are risks that were not previously considered, as they are new to the organization.
As market volatility becomes an increasing issue, investment and financial advisors will be looked to for advice. Many clients will come seeking strategies for risk mitigation or need aid with already-happening crises with their portfolio. We have identified some of the more common emerging risks many of our clients have faced:
- Supply chain interruption
- Credit risk
- Agriculture/livestock loss
- Political risk
- Natural disasters and adverse weather
- Cybersecurity issues/breaches
One way financial advisors can help clients avoid these emerging risks is to understand what typically isn’t covered by traditional insurance. By learning these uninsured risks, advisors can better focus on building long-term success plans. As the term states, an emerging risk is not something financial advisors and their clients can see before it occurs. However, both parties can take steps towards mitigating those damages before they even happen.
A solution growing in popularity is an 831(b) plan, which allows a business to self-insure through non-taxable funds designed specifically to protect against uninsured risks. These policies are broadly written and allow coverage through means of self-insurance, thus allowing businesses to get back on their feet in the case of something unexpected.
Although an 831(b) plan is a strong, viable tool for self-insuring risk and was validated through recent events such as COVID-19 and the hardening of the P&C Insurance market, we have seen the IRS scrutinize 831(b) plans in general without offering any guidance concerning compliance. In fact, Congress created this tax code nearly four decades ago, during the 1980 liability crisis, as the insurance market hardened—much like we are seeing today. The spirit of the 831(b) tax code is to allow small to midsize businesses to self-insure against risks that may not be covered by traditional insurance—something that is more important than ever in today’s quickly fluctuating economy.
In today's unpredictable business environment, it is crucial for advisors to stay ahead of emerging risks that traditional insurance might overlook. Understanding these risks and implementing strategies such as the 831(b) plan can provide a vital safety net for businesses.
Dustin Carlson is the President of SRA 831(b) Admin, an 831(b) plan administrator.