/
Captive Insurance Captive Insurance

Captive Insurance - PowerPoint Presentation

karlyn-bohler
karlyn-bohler . @karlyn-bohler
Follow
435 views
Uploaded On 2017-09-27

Captive Insurance - PPT Presentation

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

insurance captive captives risk captive insurance risk captives tax 831 company premiums risks business insured parent irs 2015 section

Share:

Link:

Embed:

Download Presentation from below link

Download Presentation The PPT/PDF document "Captive Insurance" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.


Presentation Transcript

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

70Slide71

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

71Slide72

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

72Slide73

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

74Slide75

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