Environment and Middle Market UpdateActivity Society of Risk Management Consultants April 8 2016 Panelists Patrick Theriault Managing Director Strategic Risk Solutions Charles Chaz Lavelle ID: 591168
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Slide1
Captive Insurance Environment and Middle Market Update/Activity
Society of Risk Management Consultants April 8, 2016
Panelists
Patrick Theriault
Managing Director, Strategic Risk Solutions
Charles (Chaz) Lavelle
Bingham Greenebaum Doll LLPSlide2
Presentation Outline
Captive Insurance – The BasicsMarket Update Insurance Company Taxation
The Foundation
Latest Developments with Small Captives
Typical Structures and Case StudiesQ&A
2Slide3
Captive Insurance – The Basics
3Slide4
Captive Insurance – The Basics
4Slide5
Captive Insurance – The Basics
5
A licensed insurance company
Formed to insure or reinsure the risks of its owners or related parties of their choosing
Regulated under special legislation regulating captives
Located onshore or offshore
Generally licensed in only one domicile
Definition:
Characteristics
A closely held insurance company that is owned and controlled primarily by its insuredsSlide6
Captive Insurance – The Basics
6
Why Captives are Formed?
Reduce Cost of Risk
Increase Control
Lack of Available Coverage or Breadth of Coverage
Industry Bias (medical malpractice, trucking, etc…)
Entrepreneurial Opportunities (third party risk)
Tax Liability Management
Complete insulation/separation from the commercial insurance market is challenging due to capital requirements.Slide7
Captive Insurance – The Basics
7
*Small captives (aka 831b) have become popular with smaller entities
Size
of
Insured
Large
Small
Small
Insurance
Company*
Rent-A-
Captive
Single Parent Captive
Group Captive, RRG
MediumSlide8
Captive Insurance – The Basics
8
Formation Timeline:
Feasibility/structuring: 30-365 days
Implementation: 30-90 days
Formation Costs: $35,000 - $100,000+
Ongoing Operating Costs: $55,000 - $150,000+Slide9
Market Update
9Slide10
2015 Captive Industry Review
Captive industry growth slowed slightly in 2015 but remains strong at 4.8%. This compares to 8.6% in 2014. 498 new captive formations and a net addition of 202 (100 net increase worldwide according to Business Insurance Survey).Slow down in small captive growth due to IRS scrutiny and uncertainty over the 831(b) election.
More cell formations than standalone captives.
Closures were significantly higher this year, up 75.1% from 2014. Reasons for this include:
Re-domestications (reported in domicile figures).
Parent organization consolidations, especially in the healthcare industry.
Some small captives closures due to parent company acquisitions, concerns over IRS scrutiny and market conditions.
Soft commercial market conditions, primarily affecting group captives and RRGs.
10Slide11
Domicile Review
2015 SRS PredictionHome states with captive laws and receptive regulators will continue to grow – established domiciles will hold their own.
2015 Activity
The growth rate of 4.8% is consistent with the growth rate we have seen outside of the emerging domiciles in recent years.
New formations, including re-domestications, were down 5.5%. New formations have decreased for the past two years after several years of increases.
Growth continued to be driven by small captives and cells with highest growth totals seen in domiciles attracting these structures.
11Slide12
Total Active Captives
2015
2014
%
change
2015
2014
%
change
Bermuda
797
800
-0.4%
Arizona
110
114
-3.5%
Cayman
708
759
-6.7%
North Carolina
94
52
80.8%
Vermont
596
587
1.5%
Kentucky
92
122
-24.6%
Utah
450
422
6.6%
Oklahoma
73
47
55.3%
Delaware
323
333
-3.0%
Missouri
50
47
6.4%
Nevada
202
160
26.3%Alabama42405.0%Hawaii1971941.5%Michigan231553.3%Montana19617710.7%New Jersey221729.4%DC1931911.0%Texas211275.0%South Carolina1671585.7%Connecticut10742.9%Tennessee1277081.4%Total6,9396,8391.5%
12
Figures per Business Insurance SurveySlide13
New Captive Formations
2015
2014
change
2015
2014
change
Bermuda
22
16
+8
Arizona
7
13
-6
Cayman
22
22
0
North Carolina
42
49
-7
Vermont
33
16
+17
Kentucky
1
0
+1
Utah
66
106
-40
Oklahoma
26
37
-11
Delaware
48
87
-39
Missouri
5
12
-7
Nevada
50
26
+24
Michigan
89-1Hawaii1915+4New Jersey53+2Montana3934+5Texas1012-2South Carolina3020+10Connecticut330DC550Total498527-5.5%Tennessee5742+15
13
Including re-domestications
Figures per SRS SurveySlide14
Captive Closures
2015
2014
change
2015
2014
change
Bermuda
22
47
-25
Arizona
11
5
+6
Cayman
74
21
+53
North Carolina
1
0
+1
Vermont
28
12
+16
Kentucky
31
6
+25
Utah
38
26
+12
Oklahoma
0
0
0
Delaware
22
20
+2
Missouri
4
0
+4
Nevada
4
9
-5
Michigan
10+1Hawaii165+11New Jersey10+1Montana197+12Texas10+1South Carolina195+14Connecticut000DC26-4Total29616975.1%Tennessee20+2
14
Including re-domestications
Figures per SRS SurveySlide15
Cell and Series Captives
2015 PredictionContinued captive growth to be driven by small captives and cells.
2015 Activity
The expansion in cell and series LLC legislation creating separate legal entities at the cell/series level has blurred the lines between standalone captives and cells/series.
Delaware legislation gives series equal recognition as a captive insurance company.
2015 saw the first court case involving a cell (Pac Re 5-AT v. AmTrust N.A.). The
Montana court upheld the cell structure.
With similar benefits available in a cell/series many owners are going this route rather than forming standalone captives.
15Slide16
Cell and Series Captives (Continued)
16
Cells
at 12/31/2014
Net Additions
Cells at 12/31/2015
Captives + Cells at 12/31/2015
Cayman
606
-3
603
1,310
Delaware
624
78
702
1,061
Tennessee
206
98
304
430
North Carolina
120
120
240
334
Vermont
78
12
90
678
Utah
71
-3
69
516
Total
1,705
282
2,011
3,149
The growth in number of cells and series in 2015 across these six domiciles alone exceeded captive growth. Cells and series are growing at much faster rate. This trend is likely to continue as domiciles compete on legislation.
Figures per SRS SurveySlide17
New and Emerging Domiciles
We continue to see interest in home state re-domestications with more domicile choice and greater awareness of self-procurement tax.The newer domiciles are gaining traction particularly among home state parent organizations.
Texas now has 21 captives and expanding among Texas businesses. Broadened the captive law in 2015.
Connecticut has 10 active captives and expect expansion among Connecticut companies, protected cells and medical stop loss programs.
New domiciles continue to enter the captive market.
Georgia updated its captive law in July to reactivate its captive industry particularly for Georgia captive owners.
Arkansas recently licensed its first special purpose captive.
17Slide18
Small Captives
2015 PredictionContinued captive growth to be driven by small captives and cells…… unless material negative changes result from recent section 831(b) amendments.
2015 Activity
Small captives continued to account for a significant portion of the industry’s growth in 2015.
Formations slowed in 2015 as some potential owners waited for the outcome of potential changes to the 831(b) provisions and general uncertainty about the environment with increased IRS scrutiny.
18Slide19
Medical Stop Loss Captives
2015 saw continued growth for both single parent and group MSL captives, both heterogeneous and homogeneous. We are seeing an increase of larger mid-size employers (250 EE – 1,000+) joining group captives (part of an already established consortium, association or homogenous group – RRG’s).
The use of captives for voluntary employee benefit plans:
To mitigate the financial gaps being created by the movement to high deductible health plans, products like group critical illness, group accident, hospital indemnity plans, etc. are being introduced by plan sponsors large and small. This is driving captive owners to again consider expanding use of captives to include these types of voluntary employee benefit plans.
19Slide20
2016 Market Trends/Predictions
General slowdown driven byContinued soft market.Healthcare sector still difficult for captives.
Year of review, restructuring and re-start for small captives (significant time demand for all involved).
Offset in part by continued interest in Medical Stop Loss and specific sectors such as Transportation.
Home state preference leading to continued growth in newer domiciles and some re-domestications.
Quieter Federal Regulatory Environment after a busy year – Election year.
Difficult investment environment.
Number of captives considering service provider change to increase.
20Slide21
Insurance Company Taxation
21Slide22
Deductibility of Future Payments for Claims
A business can only deduct payments for damages caused to others upon payment.
An insurance company can estimate its future payments for losses and currently deduct their present value.
Thus, if one anticipates a loss of $1,000,000 that will have to be paid in 10 years, a business cannot deduct it until payment is made in year 10, but an insurance company can deduct most of it in year 1.
Thus, there is a tax advantage if a business sets up a captive.Slide23
Captive Principles from 100,000 Feet
Captives should only be formed for non-tax business purposes and should only retain a comfortable level of risk and volatility.
The owners must want to be in the insurance business (willing to assume and share insurance risk).
The captive must be operated as an insurance company (observing formalities and operating at arms length with the insureds).Slide24
Captive Tax Parameters
Single Parent vs. Group Captive.
Foreign Captive vs. Domestic Captive (including a captive electing to be taxed as a domestic).
Taxable environment vs. Tax exempt environment.Slide25
Prerequisites for finding “insurance” for tax purposes – some courts
Have a non tax business purpose for establishing the captive.
See the discussion in the Feasibility Session.
The arrangement cannot be a sham.
Purpose other than tax benefits.
Proper documents.
Actions comport with the documents.Slide26
Court tests for “insurance” for Federal income tax purposes
The most recent Tax Court decisions have required the following to find “insurance” for Federal income tax
An Insurance Risk must be involved.
Common Notions of Insurance.
Risk Shifting.
Risk Distribution.Slide27
Insurance Risk
Insurance Risk.
There must be a realistic chance that a loss will occur (it cannot be speculative).
There must be a chance that a loss will not occur (there must be some fortuity).
It differs from a business risk.
It differs from an investment risk. Slide28
Risk Shifting
Risk Shifting (from Rev. Rul. 2002-91).
Risk Shifting occurs if a person facing the possibility of an economic loss transfers some or all of the financial consequences of the potential loss to the insurer, such that a loss by the insured does not affect the insured because the loss is offset by the insurance payment.
If an insured insures it automobile with an insurance company, then the insured is indifferent FROM A FINANCIAL STANDPOINT as to whether the insured wrecks the automobile. Slide29
Risk Shifting
Risk Shifting is often met if
The captive is well capitalized.
No one guarantees the performance of the captive. Slide30
Risk Shifting Fact Situations
#1 – X is an offshore captive with $24,000 of capital and $1,200,000 of premiums (a 50 to 1 premium to surplus ratio); a typical premium to surplus ratio is closer to 3:1. Is there risk shifting? What effect if the regulator approved the arrangement?#2 – Same as #1, except the capital was $400,000 (3:1 premium to surplus ratio.)
#3 – Same as #1, except the captive is a cell, rather than a stand-alone captive.Slide31
Risk Distribution
Risk Distribution requires a sharing of risks.
There must be sufficient exposure units.
The IRS believes it also requires that there be many insureds.
One test sometimes used is that an insured not pay its own losses.Slide32
Risk Distribution in the Courts
The courts have found that risk distribution existed in either of two scenarios:
Sufficient outside business.
“brother-sister” insurance.
Rev. Rul. 2002-90-12 entities each between 8-15% of total premium
Rent-A-Center & Securitas cases appeared to look to exposure units more than entitiesSlide33
Risk Distribution Through Third-Party Insurance
(1)
Third-Party or Outside Insurance
Unrelated
Insureds
Parent
Insurance
Subsidiary
Operating
Subsidiaries
Insurance
Insurance
Insurance
100 %
100 %Slide34
Risk Distribution Through Third-Party Insurance
(4)
The Courts of Appeals have also ruled for the taxpayer in four “outside” business cases:
Sears,
Amerco, Harper Group
and
Ocean Drilling
. The lowest amount of outside business in these cases was 29%.
Rev. Rul. 2002-89 ruled that there was no insurance of the parent where 90% of the captive’s premiums were from the parent, but there was parent insurance where less than 50% of the captive’s premiums were from the parent.Slide35
Rev. Rul. 2002-89 –
Assumes all other facts are “plain vanilla”
Not
Insurance
Parent
Unrelated
Insureds
10% of the
Premiums
Captive
100 %
ownership
90%
of the
Premiums
Parent
Unrelated
Insureds
More than
50% of the
Premiums
Captive
100 %
ownership
less than
50% of the
Premiums
InsuranceSlide36
Third Party Business – How do you find it ?
There are several sources of unrelated business.
Some brokers, captive managers, etc. will develop “pools” wherein captives reinsure a pro-rata portion of the risks of a number of the sponsor’s customers.
Similarly, a captive may reinsure a commercial carrier.
Owners or General Contractors may create a captive to insure all the contractors on a major construction project.
Customers, franchisees, suppliers, etc. Are also sources of unrelated business. Slide37
Pooling
There are different ways to design pools (assume A owns A Co [an operating company] and A Captive; the same for B, C, … Z; each Co pays the same premium):
A Co, B Co, C Co, etc. insure with a fronting company which reinsures an equal share with each Captive.
A Co insures with A Captive; A Captive reinsures with Pooling Co., as do B Captive, C Captive, etc. Pooling Co. re-reinsures an equal share to each of the captives.
Same as above, except that instead of reinsuring and re-reinsuring with Pooling Co, it is done with contracts.
There is non-precedential IRS authority for most pooling situations.Slide38
Risk Distribution Through
Brother-Sister Insurance (1)
“Brother-Sister” Insurance
Oper.
Sub
Oper.
Sub
Oper.
Sub
Oper.
Sub
Oper.
Sub
Insurance
Subsidiary
100%
Parent
100%
100%
100%
100%
100%
InsuranceSlide39
How Many Insureds ? (1)
Rev. Rul. 2005-40 ruled that if there is only one insured, there can never be risk distribution, even if the insured and insurance company are unrelated, the insurer is adequately capitalized and all aspects of the relationship are done at arms-length.
Rev. Rul. 2005-40 also ruled that there can never be risk distribution, if there are two insureds, one with 90% of the insurance and the other with 10%.Slide40
How Many Insureds ? (2)
In Rev. Rul. 2002-90 found risk distribution present where there were 12 subsidiaries, none of which had less than 5% nor more than 15% of the captive’s risks, and the captive had a significant volume of independent, homogenous risks.
In the 2014 cases of Rent-A-Center and Securitas, the Tax Court seemed to rely on sufficient exposure units (e.g. 15,000 employees, 7,000 vehicles and 3,000 stores), rather than the number of insured entities or concentration of risks in one subsidiary.Slide41
Disregarded Entity an Insured?
(1)
Do “Pass Through” Entities Count as Insureds?
A single member LLC (SMLLC) is generally disregarded for income tax purposes unless it elects to be treated as a corporation. If the owner is a corporation, the LLC is treated a division. If the owner is an individual, the LLC is treated as a proprietorship.
The IRS believes that a disregarded SMLLC is not an insured, but its owner is the insured (Rev. Rul. 2005-40).Slide42
Insurance Distribution Fact Situations
#1 The captive issues insurance policies to 15 “brother-sister” affiliates that own no stock in the captive. One subsidiary pays 15% of the premium. The rest are between 5 and 15% of the premium.
Is there risk distribution?
#2 The same as #1 except one operating subsidiary pays 60% of the premium, and there are 5 other subsidiaries that each pay 8% of the premium.
Is there risk distribution?#3 Y operating company buys insurance from its captive, which also participates in a pool. The captive reinsures 51% unrelated business of the same kind of risks as the related party risks.
Is there risk distribution?
Same as #3, except the unrelated business is 10%.Slide43
Common Notions of Insurance
(2)
In short the captive should act like a “real” insurance company, including:
Reasonable capitalization; no parent guarantee
Reasonable premiums (can there be retrospective premiums?)
Standard policy forms (can there be retroactive insurance?)
Reasonable reserves
Risk distribution (homogenous risks? From multiple states?)
Standard investments (are related-party loans permitted?)
No commingling of assets with the insureds
Maintain corporate formalities
Independent operation
Separate letterhead, etc.
Reasonable regulation?
Licensed in all jurisdictions where the risks are located?
Non-tax business purposeSlide44
Loan Backs
Standard Investments
Insurance companies often match the maturities of their investments with the anticipated timing of claims payments. The favorable Revenue Rulings in 2002 and 2005 assumed that there were no inter-company loans.
In Notice 2005-49, the IRS has asked for comment on the significance, if any, of loans by the captive to related parties. The industry responded.
Commercial insurance companies cannot loan a significant portion of its assets to a single company.
In non-precedential documents, the IRS has often found that insurance was not present when there were large loan backs.Slide45
Section 501(c)(15) and 831(b) Companies
(1)
Sections 501(c)(15) and 831(b) provide favorable tax treatment to small insurance companies. Insurance companies qualifying under section 501(c)(15) are completely exempt from income tax. In response to perceived abuses of the section 501(c)(15) rules, the statute was tightened in 2004.
Today, a stock P&C company and companies under common control with it cannot have gross receipts in excess of $600,000; more than 50% of the gross receipts must be premiums. (Mutuals cannot exceed $150,000 of gross receipts, at least 35% are insurance premiums.) See Notice 2006-42 concerning the measurement of gross receipts.Slide46
Section 501(c)(15) and 831(b) Companies
(2)
Insurance companies qualifying under section 831(b) may elect to be taxed on their “taxable investment income” only. Section 831(b) companies are those where the greater of net written premiums or direct written premiums is not more than $1,200,000. In 2017, the limit increases to $2,200,000 and is indexed.
The premiums are counted on a controlled group basis with 50% ownership (not 80%) the threshold to be included in the group.
Once made, the election is irrevocable, unless the IRS consents.
The downside is that underwriting losses cannot offset investment income and there are limits on net operating losses carried to or from another year.Slide47
Group Captives
(1)
Even in the early years, the IRS consistently treated premiums paid to group captives as deductible, if there were enough owners, no insured dominated and the risks were shared in a common pool.
Rev. Rul 2002-91 found insurance where no member owned more than 15% of the group captive, had more than 15% of the vote, nor accounted for more than 15% of the risks insured.Slide48
IRS Scrutiny
There are anecdotal reports that the IRS is auditing a substantial number of captives electing to be taxed under section 831(b)Tax Shelter Promoter Investigations:One or more captive managers are being investigated to determine if they are tax shelter promoters
Audits of Captives Electing Section 831(b) – some of them are customers of the captive manager(s) under investigation and some are captives associated with operating companies otherwise selected for audit
Just because the IRS is investigating an issue or conducting an audit does not mean that anyone has done anything wrong
There have been no results announced from the investigation(s)
48Slide49
Audits of Captives Electing Section 831(b)
The audits are very exhaustive and usually include an interview of the principal(s) and comprehensive information requestsComprehensive information document requests:
Information from the inception of the captive, even if it preceded the years under audit
All emails, marketing materials, etc.
Comprehensive questions on how one got involved in the captive and was consulted
What commercial insurance was in place, what are the gaps and exclusions, how the captive program fit
49Slide50
Audits of Captives Electing Section 831(b)
Comprehensive Information Document Requests (cont):What is the operating company’s risk management programHow were the premiums priced
For the ten years prior to its inception, were there any losses that would have been covered by the captive program had it been in place
What is the loss experience of the related party and pool insurance
What are the investments
50Slide51
IRS Scrutiny: The Dirty Dozen
In 2015 and 2016, the IRS identified Tax Shelters as one of its “Dirty Dozen.” For the first time, captives electing section 831(b) were linked to tax shelters. “The promoters assist with creating and “selling” to the entities often times poorly drafted “insurance” binders and policies to cover ordinary business risks or esoteric, implausible risks for exorbitant “premiums,” while maintaining their economical commercial coverage with traditional insurers.”
“Total amounts of annual premiums often equal the amount of deductions business entities need to reduce income for the year; or, for a wealthy entity, total premiums amount to $1.2 million annually to take full advantage of the Code provision. Underwriting and actuarial substantiation for the insurance premiums paid are either missing or insufficient.”
51Slide52
Avrahami v Commissioner
Avrahami v Commissioner is the first case involving a captive electing to be taxed under section 831(b)The briefs were just filed; an opinion is expected in 2016
The IRS is arguing that the contracts did not have “insurance risk” but rather investment or business risk.
The IRS does not believe that economic substance is present in the captive insurance arrangement and the arrangement appears to be tax motivated.
The captive also participated in a pool that insured against terrorism, primarily against terrorism risks not available in the commercial market.
52Slide53
Protecting America From Tax Hikes Act of 2015
Protecting America from Tax Hikes of 2015 (HR 2029) which passed December 18, 2015 included changes to section 831(b):The maximum premium allowable for an insurance company electing section 831(b) is increased to $2,200,000, which will be indexed for inflation.
However, there are tighteners
The changes apply to taxable years beginning after December 31, 2016
53Slide54
Protecting America From Tax Hikes Act of 2015
To be eligible to make a section 831(b) election, an insurance company must meet either of the two following diversification tests:Test 1: No more than 20% from any one policy holderPremiums are the greater of net written or direct premiums
Related insureds are treated as one policy holder
Test 2: The same person owns the operating company and the insurance company
The details are more complex than the preceding sentence
There is a 2% de minimus tolerance for different ownership
54Slide55
Protecting America From Tax Hikes Act of 2015
The IRS can change the de minimus percentage from 2% The IRS can require information annually about these tests from each insurance company
55Slide56
Captive Structure 1
Because Son owns more in Captive* [100%] than he owns in Business [30%], Captive 1 is not eligible to make an election under section 831(b) * subject to the 2% de minimus rule
ABC Company
ABC Captive 1
Father
Son
70%
30%
100%
Insurance
56Slide57
Captive Structure 2
Because Son owns no more in Captive* [30%] than he owns in Business [30%], Captive 2 is eligible to make an election under section 831(b) * would also be subject to the 2% de minimus rule, if needed
ABC Company
ABC Captive 2
Father
Son
70%
30%
30%
Insurance
70%
57Slide58
Captive Structure 3
Because Son owns no more in Captive* [20%] than he owns in Business [30%], Captive 3 is eligible to make an election under section 831(b) * would also be subject to the 2% de minimus rule, if needed
ABC Company
ABC Captive 3
Father
Son
70%
30%
20%
Insurance
80%
58Slide59
Summary of Examples
Owner
Business
%age Owned
Captive
%age Owned
Eligible for 831(b) Election
Captive
1
No
Father
70%
Son
30%
100%
Captive
2
Yes
Father
70%
70%
Son
30%
30%
Captive 3
Yes
Father
70%
80%
Son
30%
20%
59Slide60
Mutual 4
12 corporations (A Co., B Co., C Co., etc.) insure with a mutual insurance company. A owns A Co., B owns B Co., etc. A through L are unrelated. Each of the insureds pays 8-2/3% of the premiums. The mutual would meet the 20% diversity test because no policy holder pays more than 20% of the premiums.
Mutual 4
A
60
A Co
B
B Co
C
C Co
D
D Co
E
E Co
F
F Co
G
G Co
H
H Co
I
I Co
J
J Co
K
K Co
L
L Co
Premium-8 2/3%
each insuredSlide61
Mutual 5
12 corporations insure with a mutual. A owns A Co., B owns B Co., etc. though J owns J Co. In addition to A Co., A also owns K Co. and L Co. Each of the insureds pays 8-2/3% of the premiums. The mutual would not meet the 20% diversity test because A Co., K Co. and L Co. are treated as one policy holder that pays more than 20% of the total premiums.
Mutual 5
61
A Co
A
K Co
L Co
B
B Co
C
C Co
D
D Co
E
E Co
F
F Co
G
G Co
H
H Co
I
I Co
J
J Co
Premium-8 2/3%
each insuredSlide62
Open Questions
The three goals of the amendments are narrow; they do not go into effect until 2017Over the next year there may be interpretations by the IRS and people will read the statute in light of specific fact situationsFor instance, if 20 equal insureds insure with a commercial front, which reinsures with a group captive, is that one policy holder or twenty 5% policy holdersQuestions will be identified and considered over this year
62Slide63
What Hasn’t ChangedOn their face, the amendments do not have anything to do with the definition of insurance.
If the arrangement qualified as insurance before the amendments, it remains a good insurance arrangement after the amendmentsThe consequence of failing to meet the new tests in 2017 or beyond is that the insurance company will be taxed under section 831(a), just like any insurance company with more than $2.2 million of premiums (more than $1.2 million in premiums in 2016 or before)
63Slide64
Typical Structures
and
Case Studies
64Slide65
831(b) Captive – Definition
831(b) is not a type of captive, but rather purely a tax election available to certain insurers (just like a LLC could elect to be taxed as a corporation or as a partnership)All types of property & casualty insurers, captive or traditional/commercial insurers, that meet certain requirements, could make this election
Other descriptions used for captives that often make an 831(b) election:
Small captive, micro-captive, mini-captive, enterprise risk captive
65Slide66
What works well
Common 831(b) structureCaptive Insurer Used to Prefund Self Insured Risks (Known and Unknown)
No Change to Risk Profile
Budgeting for Volatile Self Insured Risks
Common types of risks seen in 831(b) captives
Weather risks: earthquake, windstorm, flood
Difference in Limits / Difference in Conditions
Property risk and related
coverages
(i.e. Mold)
Cyber risk & excess liability
Pollution liability & clean up
66Slide67
Common 831(b) Captive Coverage Structure
67Slide68
Common 831(b) Captive Coverage Structure
68Slide69
Case Study #1
Privately held organization – Demolition, Dismantling & Asset Recovery OrganizationComplex legal structure consisting of in excess of sixteen legal entities
Performed a detailed commercial coverage and self insured claims review and identified self insured risks that could be better managed via a captive insurer
Property DIC, Excess Pollution & DIC, Medical Stop Loss, Cyber Risk Liability
Company operation review also identified high severity risk exposure for which no commercial coverage was available
Loss of Profit due to Safety Events
Third party actuarial review priced risks at slightly over $1 Million
Formed onshore single parent captive ($350K capital)
Captive owned by a Trust for the benefit of the Owner’s children
May no longer qualify under new 831(b) rules
69Slide70
Brother-Sister Approach
Not Tax-Deductible
Tax-Deductible
(Note: Subsidiaries must be legal C corporations or other qualifying “associations” but NOT disregarded entities for tax purposes)
Parent
Captive
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
12 Subsidiaries inferred from Revenue Ruling 2002-90
Premium Payments
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Case Study #2
Privately held organization - Furniture manufacturer and importer Simple legal structure consisting of only two legal entities
Client identified several self insured risk with history of manageable claims activity, but with large claims potential. Commercial review also identified some coverage gaps that could be better managed via formalized pre-funding of future claims
Business Interruption, Property Damage in Transit and Mold & Fungi, Loss of Key Employee
Third party actuarial review priced risks at roughly $900K
Formed onshore single parent captive ($250K capital)
Accessed quota share risk pool to provide risk diversification and obtain a level of risk transfer for uninsurable risks
Captive owned by certain key employees as part of compensation/retirement plan
Should still qualify under new 831(b) rules
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Common Mid Size Company Example
Brother-sister and third-party risk
Parent
Captive
Sub
Sub
Sub
Sub
Captive - Pooling
Pool Risk
50% unrelated risk stated as a safe harbor from Revenue Ruling 2002-89
Tax-Deductible
Premium Payments
Ceded Premium
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Case Study #3
Privately held organization – General ContractorSimple legal structure consisting of only four legal entities
Client identified several self insured risks with history of manageable claims activity, but with large claims potential. Third party actuarial review priced risks at roughly $500k
Captive reinsured general liability risks (Not WC) from Zurich on its Contractor Controlled Insurance Program (CCIP). Third party actuarial review priced risks at roughly $600k
Formed onshore single parent captive ($350K capital)
Captive owned by Principal and his children (via a trust) in the same percentage as they own the operating company
Should still qualify under new 831(b) rules
73Slide74
Common Mid Size Company Example
Brother-sister and third-party risk
Parent
Captive
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Captive - Unrelated
Third Party
50% unrelated risk stated as a safe harbor from Revenue Ruling 2002-89
Tax-Deductible
Premium Payments
LLC
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Patrick Theriault
Managing Director
Strategic Risk Solutions,
Inc.
patrick.theriault@strategicrisks.com
Tel: 802-861-2630
Charles (Chaz) J. Lavelle
Senior Partner
Bingham Greenebaum Doll LLP
clavelle@bgdlegal.com
Tel: 502-587-3557
Questions & Answers
75