• The Purpose of a Captive • Captives vs. Traditional Insurance • Structuring a Captive • Determining the Feasibility and Goals of a Captive • Domicile Selection • Partner Selection • Operating a Captive • Captive Advantages 2
• Pricing Stability • Greater Control over Claims • Purchase Based on Need • Increased Coverage • Tax Benefits • Underwriting Flexibility • Investment Income • Access Reinsurance Market • Capture Underwriting Profit • Incentive for Loss Control • Improved Claims Review and • Reduced Insurance Costs Processing 3
Minimize Costs Risk Management and Maximize Profits Complement Coverage for Your Estate or Business Changing Needs Planning Strategies 4
• Design the captive with risk management as the primary focus, for valid business purpose • Adhere to IRS Revenue Rulings and all available guidance including requirements for Risk Shifting and Risk Distribution • Assure that the captive is operated as a bona fide property & casualty insurance company in accordance with the accepted business plan and a reasonable investment plan • Underwrite policies that offer meaningful coverage at appropriate premium levels • Avoid structures that are “too good to be true” in order to generate predictable results 5
Front for Purchase Warranty Insurance Premium Company Independent Company Captive Distributor Program Reduced Product Insurance Policy Cost = Cost of Underwriting Profit Warranty Reinsurance Premium Captive X 12.5% Quota Share Trust X
Each Captive receives Each Captive receives $926,375 share of Premium $926,375 share of Premium Primary Insurer (front) Captive 1: Captive 5*: Each Captive Owned by Trust #1 Owned by Trust #5 pays quota share of Claims Captive 2: Captive 6*: Owned by Trust #2 Owned by Trust #6 Captive 3: Captive 7*: Owned by Trust #3 Owned by Trust #7 Captive 4*: Captive 8*: Owned by Trust #4 Owned by Trust #8 7
• Feasibility Studies 8
• Premium payments made by the operating company allow the client to further manage business risk and should be tax-deductible as ordinary and necessary business expenses • Captives which make an election under IRC Section 831(b) collect annual premiums of $1.2MM or less and are entitled to attractive tax benefits • Premiums received by the captive are tax-exempt under the annual $1.2MM premium test • Captive underwriting profits and surplus accumulation are also tax-exempt; only investment income is taxable annually 9
• Considerations: – Responsiveness of Regulator – Availability of service providers – Capital requirements – Investment restrictions – Underwriting restrictions – Tax rates 10
Captive Manager Actuarial Legal Firm Counsel Audit Financial Firm Advisor Tax Counsel 11
• Accounting consolidation – Timing of Audit – Cost considerations • Captive Manager • Self-Managed Captives 12
• Company: Large manufacturer with large retentions on GL program • Problem: GL carrier wanted $100K to front the program, plus $2.5 million in collateral. The company needed insurance policy evidence to satisfy customer contractual requirements • Solution: Established a captive, costing $60,000/year to run. Issue certificates. “Collateral” is lent back to the parent corporation • Results: $40,000/year in savings, $2.5 million improved liquidity
• Company: Engineering firm with Marine Services subsidiary • Problem: Captive was previously established to provide certificates for professional liability similar to Example #1. During the marine renewal, negotiations with the hull underwriter were not going well. Large premium increases were proposed for the vessel fleet, despite a favorable loss ratio • Solution: The company calculated a loss pick to place the program with their captive. They told the commercial underwriters to renew within $10,000 of the loss pick, “or we are putting it into the captive”. A quote within the requested range magically appeared the next day. • Results: The program was renewed, saving well over $100,000
• Company: Large chemical manufacturer • Problem: Wanted to reduce variability in self-insured losses from year to year and quarter to quarter. • Solution: Joined a group captive to insure its deductibles, including a substantial new retention in the credit risk program • Results: $2 million of variability removed; $1.5 million of premium saved on credit risk; $35,000 savings for GL fronting fees
• Company: Privately owned home builder • Problem: Profitable company, but taking risks, ie no product liability or warranty coverage was purchased – “it’s too expensive and we’ve never had a claim” • Solution: Set up a captive owned by the family to insure these risks with a premium just over $1 million per year. Took an 831(b) election. • Results: Now, they have $5 million in assets to pay for a problem if one arises (after 4 years), while saving the owner about $350,000 per year in income taxes
• Company: US-based multi-national – post bankruptcy • Problem: Huge US tax loss carry forwards – aka “NOLs”. Post bankruptcy, they had virtually no US operations, and a limited ability to use up the US NOLs. Foreign operations are still profitable, paying income tax to foreign governments at an average tax rate of 23.5%. Balance sheet showed warranty reserves of over $50 million • Solution: Set up a US domiciled captive subsidiary - insure all uninsured risks - charge premium to local sub’s P&L - Make reasonable return in US sub • Results: Removed $50 million in liability from the balance sheet. Saved over $10 million a year in taxes. Used up a portion of the NOLs, which would have otherwise expired as useless.
• Company: Larger retailer with over 300 franchisee owners • Problem: Franchisee spending significant premiums via separate programs for GL, Property, WC, and some benefits programs • Solution: Company sponsored a captive solution to provide a turnkey insurance solution, in some cases, behind a front company for regulatory compliance • Results: This program not only saves franchisees significant premium (and time), the program also generates over $10 million annually in profit for the franchisor
• Company: A private equity firm with over 70 portfolio companies • Problem: Company wanted to utilize a combined D&O program for the firm, as well as its portfolio companies. While this program would save $2 million per year, the required SIR was too high for the individual companies, so it was unattractive • Solution: A captive was formed to buy down the deductibles for the portfolio companies to tolerable levels • Results: $2 million saved, and deductibles cut in half for the portfolio companies
• Revenue Ruling 78-338 – The Internal Revenue Service held that a Group Captive Insurance Company - where no shareholder’s individual risk exceeded 5% of the total risks of the captive - had sufficient risk shifting and risk distribution • Revenue Ruling 2001-31 - The Internal Revenue Service abandoned its “economic family theory” with respect to captive insurance transactions • Revenue Ruling 2002-89 – Provides a safe harbor determination for risk shifting if a captive has more than 50% unrelated business risk • Revenue Ruling 2002-90 – Reviews Brother and Sister Operating Subsidiaries and establishes the Rule of 12 for safe harbor purposes • Revenue Ruling 2002-91 – If the liability of each company is no more than 15% of total risks insured by the captive, significant Risk Shifting and Risk Distribution exists • Revenue Notice 2004-65 – The service stated that 831(b) no longer should be identified as “listed transactions” for purposes of disclosure, registration, and list maintenance requirements • Revenue Ruling 2005-40 – Reviewed cases in which the captive underwrote a significant amount of third party risks, risk distribution and risk shifting were found to be present, even when the captive insurance companies that were wholly owned, or nearly wholly owned by its insured’s • Revenue Ruling 2008-8 – This ruling explains how arrangements between an individual cell and its owner are analyzed for purposes of determining whether there is adequate risk shifting and risk distribution to constitute insurance • Proposed Regulations – Initial Draft (REG–119921–09) – On September 14, 2010, the Treasury proposed that domestic series organizations (typically a series limited liability company – Series LLC) would be treated as a separate entity formed under local law and general tax principles 20
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