Captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups. Using a captive insurer is a risk management technique where a business forms its own insurance company subsidiary to finance its retained losses in a formal structure. While larger companies have long been in the captive space, higher insurance rates, expansions in commercially uninsurable risks and the development of low-cost captive structures have made captives more attractive for certain middle market and closely-held businesses. In this presentation, you’ll learn how using captive structures can help you manage risk, reduce insurance costs and even achieve your estate or succession planning goals. For more information visit http://www.cbiz.com

1. Don’t Be Held Captive: Go Captive to Manage Your
Risk and Expenses
Presented by
Stuart Anolik, Esq.
Managing Director, CBIZ MHM, LLC.

2. Strategic Edge Series
• Seven Core Principles to Maximize the Value of Your Business
During Its Life and Upon its Sale – May 18th
• Creative Compensation Strategies to Maintain Morale and Retain
Talent – June 22nd
• Don‟t Be Held Captive: Go Captive to Manage Your Risk and
Expenses – July 20th
• Federal Incentives That Can Show You the Money – August 17th
• Protecting Your Legacy with Succession Planning – September 21st
• State Tax Nexus: No Physical Presence Required – October 26th
All these webinars are from 2:00 – 3:00 ET. Here is the link for
registration for any of these webinars - www.cbiz.com/strategicedge
2

3. Agenda
1. Introduction to Captive Insurance
2. Why CBIZ
3. Tax Issues Related to Captive Insurance
4. Opportunities

4. Definition of a Captive
“An insurance company owned and controlled by
its policy holders.”

5. Captive Illustration
Owner
Premiums
Operating Business Captive Insurance
(“Insured”) Company (“Captive”)
Insurance Policies

6. CBIZ MHM Captive Insurance Services
CBIZ MHM is uniquely qualified to provide “turn-key” consulting services
in regard to captive insurance as a result of its expertise in (i) accounting
and tax for captive insurance companies through its Financial Services
group and (ii) property and casualty insurance services through its
Employee Services group, which includes our property and casualty
professionals.
CBIZ MHM can therefore develop and implement captive insurance
solutions for traditional insurance coverages as well as for supplemental
or non traditional coverages such as business interruption

7. Captive Benefits
•Reduced Insurance Costs:
•Retention of underwriting profits
•Claims Settlement
•Casualty premiums are deductible
•Self-insurance is funded with after-tax dollars.
•Risk Management:
•Customized coverages.
•Not available in commercial markets
•Overly expensive
•Claims Management
•Wealth Preservation:
•Asset protection
•Owner control of stand-alone captive
•Flexible ownership structure

8. How Does Captive Insurance work?
Independent actuary determines
premiums
Independent actuary underwrites
coverages
Generally, casualty premiums are tax
deductible
Owner directs investments
Insured submits claims to captive
Captive controls claims management
and settlement
Owner retains underwriting profit and
investment income
Dividends can be paid to owner

9. Examples of Non Traditional Risks
Accounts Receivable Loss of key customer
Administrative actions Loss of key employee
Business interruption Loss of key supplier
Deductibles/Exclusions Mold
Earthquake Product recalls/warranty
Intellectual Property Subcontractor default
Litigation expenses Terrorism

10. Tax Implications
• Insurance companies, including Stand Alone Captives
– Anticipated loss reserves (subject to certain discounts) allowed
as a deduction against underwriting income and investment
income
• Small P&C Companies
– Have up to $1,200,000 Premiums. Are taxed on investment
income and NOT underwriting profits - Tax rate is 36%.
• See IRC Section 831(b).
– Beneficial for most medium sized companies.

11. Key Issue: Premium Deductibility
 Treas. Reg. Section 1.162-1(a): Business expenses
deductible from gross income included the ordinary and
necessary expenditures directly connected with the taxpayer‟s
trade or business. Among the items included in business
expenses are advertising and other selling expenses,
together with insurance premiums.
 No definition in the Internal Revenue Code or regulations of
“insurance”. Rely on judicial interpretation-Helvering v.
LeGierse, 312 U.S. 531 (1941), must be risk shifting and risk
distribution of insurance risk.
 Self Insurance is not deductible, unless loss sustained.

12. Risk Shifting and Distribution
• Risk Shifting- the transfer of the risk to separate party
• Risk Distribution- enough independent risks are being
pooled to invoke the “actuarial law of large numbers”
(e.g., spread risk among a large group)

13. Risk Shifting
• 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
• IRS will look to facts and circumstances
– Parental Guarantees

14. Risk Distribution
Pooling of Premiums
– Risk distribution entails a pooling of premiums, so that a potential insured
is not in significant part paying for its own risks
– When a company “insures” unrelated risks, the arrangement constitutes
insurance if a significant percentage of unrelated risks exists
• See, Ocean Drilling & Exploration Co, 988 F2d 1135, 1152-53 (Fed
Cir 1993); Sears, Roebuck & Co, 96 T.C. 61, 100-02; Harper Group v
Comr, 96 T.C. 45, 58 (1991)
– Brother-sister subsidiary corporations (i.e., subsidiary corporations of the
same parent) may establish an arrangement and qualify as insurance for
federal income tax purposes even if there are no insured policy-holders
outside the affiliated group so long as risk shifting and risk distribution are
present
• Rev. Rul. 2008-8 citing Humana, Inc, 881 F.2d 247 (6th Cir 1989);
Kidde Industries v US, 40 Fed Cl (1997); Rev. Rul. 2002-89
– A parent corporation with a direct arrangement with its own insurance
subsidiary will still require sufficient risk pooling
• See Humana, Inc, at 257 (6th Cir 1989)

15. IRS’s Historical Position -
The Economic Family Doctrine
• Rev. Rul. 77-316, IRS position that risk shifting and distribution do not exist
in the context of a single economic family (i.e., parent-subsidiary)
• Exception: In Rev. Rul. 78-338, the IRS conceded that sufficient risk
shifting and distribution are present where 31 unrelated parties pool
risks
• In Rev. Rul. 2001-31, the IRS abandoned its position that risk shifting
and distribution do not exist in the context of a single economic family
• It now appears arm‟s length premium and loss reserve deductions
attributable to brother-sister risk (i.e., other affiliates of the parent) will be
accepted by the IRS
• But premium and loss reserve deductions attributable to parent risk will not
be allowed without presence of significant unrelated party risk measured by
premiums
• (30%?)(50%?)

16. Revenue Ruling 2002-89 Unrelated Risk Ruling
• Single parent captive otherwise properly formed and
operated (adequate capital, no parent guarantees, loan
backs, etc.)
• Not “insurance” if 90% of risks/premiums come from the
parent
• “Insurance” if less than 50% come from the parent and
the remainder are from unrelated parties
– If your captive can have 50% 3rd party risk, may apply for a
favorable tax ruling from IRS

17. Revenue Ruling 2002-90
IRS Sibling Ruling
• Single parent captive otherwise properly formed and
operated (adequate capital, no parent
guarantees, loan backs, etc.)
• Insures 12 domestic subs - parent a holding
company; no sub accounts for less than 5% or over
15% of total risk/premium
• “Insurance” under brother/sister doctrine

18. Revenue Ruling 2002-91 –
Group Captive Ruling
Facts:
• Industry group liability captive; exact number of
participants not specified
• No member owns over 15%; has over 15%
of vote; or accounts for over 15% of risk/premium;
implies 7 equal owners OK
• No assessments or refunds
IRS Holding: Captive constitutes an “insurance company” and premiums
paid by participants are deductible
• Valid non-tax business purpose was a key factor
• IRS reinforces prior rulings on group captive
insurance arrangements

19. Revenue Ruling 2005-40
• In Ruling 2005-40, the IRS gave four situations showing
specific examples of what did or did not represent insurance
– In situation 1, the IRS said there was no insurance if
there is only one insured
– The same is true if there are two insureds - - one of
which has at least 90% of the insurance
» This was true for Situations 1 and 2 even if the parties
were completely unrelated and all formalities were
otherwise met
– The IRS ruled that single member LLCs that are “disregarded”
for all other tax purposes are not counted as insureds
– Showed that single member LLCs that elect to be treated as
corporations are counted as insureds

20. Caveats
The captive must still establish:
• Presence of risk distribution
• That the captive should be respected as a separate and distinct
taxable entity, i.e., it is not a sham

21. Non-Sham Status
• Insurance status continues to require respect for the
captive as an entity separate and distinct from its
economic family:
– Valid non-tax business purpose
– Adequate capitalization
– No parental support agreements
– Limited loan backs of captive assets to parent or affiliates
(“circularity of cash flow”)
– Formation of captive in other than a weakly or non-regulated
offshore domicile

22. Notice 2005-49
• In Notice 2005–49, the IRS asked for public comment
on:
“the circumstances under which
qualification of an arrangement
between related parties as insurance
may be affected by a loan back of
the amounts paid as „premiums‟.”

23. Notice 2005-49
• The comments state that if each of these four
factors are present in a loan back, there is
insurance (if insurance otherwise exists):
– Bona fide indebtedness (enforceable; reasonable terms and
rates; appropriate security)
– Permitted or approved by the regulators
– Sufficient liquidity of the insurance company
– Sufficient liquidity of the borrower

24. Notice 2005-49
• If less than all four factors are present, the comments
state that the facts and circumstances must be
reviewed to determine if the investment function
undermines the essence of insurance

25. Cell Company Structure
POOLED LAYER - CORE CAPITAL
Cell A Cell B Cell C Cell D

26. Cell Captives-Revenue Ruling 2008-8
IRS guidance of when a cell of a protected cell company can enter
into a transaction which is treated as insurance for federal income
tax purposes, and when amounts paid to these cells is deductible as
“insurance premiums” under Section 162.
 Example 1: X, a corporation that owns Cell X, enters into a
contract hereby Cell X insures professional liability risks of X.
Cell X does not enter into any arrangements with entities other
than X.
 IRS finds the arrangement between X and Cell X is akin to
a parent and its wholly owned subsidiary, and in the absence
of unrelated risk, lacks the requisite risk shifting and risk
distribution to constitute insurance.

27. Cell Captives-Revenue Ruling 2008-8
Example 2: Y, a corporation, owns all stock of Cell Y, as well as all the
stock of 12 subsidiaries. (Mirrors facts of Rev. Rul. 2002-90). The 12
subs have a significant volume of independent, homogenous
risks, insured into Cell Y. No sub has coverage for less than 5% nor
more than 15% of the total risk insured by Cell Y.
• IRS finds the subsidiaries have shifted the liability risks to Cell Y.
The premiums are pooled such that a loss by one sub is not in
substantial part paid from its own premiums. Had the subs of Y
entered into identical arrangements with a sibling corporation that
was regulated as an insurance company, the arrangements would
constitute insurance and the premiums would be deductible under
Section 162.

28. Captive Insurance Companies – IRS Notice 2008-19
 Notice 2008-19 requests comments on further guidance to address issues that
arise if those arrangements do constitute insurance
 The Notice provides guidance that would address (a) when a cell of a Protected
Cell Company is treated as an insurance company for federal income tax
purposes, and (b) some of the consequences of the treatment of a cell as an
insurance company.
 The proposed guidance would include a rule that a cell of a would be treated as
an insurance company separate from any other entity if:
 the assets and liabilities of the cell are segregated from the assets and
liabilities of any other cells and from the assets and liabilities of the Protected
Cell Company
 based on all the facts and circumstances, the activities of the cell, if
conducted by a corporation, would result in its being classified as an
insurance company within the meaning of §§ 816(a) or 831(c).

29. IRS Notice 2008-19
Effect of insurance company treatment at the cell level under the proposed rule:
• Any tax elections that are available by reason of a cell‟s status as an insurance
company would be made by the cell;
• The cell would be required to receive an employer identification number (EIN) if it
is subject to U.S. tax jurisdiction;
• The activities of the cell would be disregarded for purposes of determining the
status of the Protected Cell Company as an insurance company for federal
income tax purposes;
• The cell would be required to file all applicable federal income tax returns and
pay all required taxes with respect to its income; and
• A Protected Cell Company would not take into account any items of
income, deduction, reserve or credit with respect to any cell that is treated as
an insurance company under the proposed rule making.

30. Internal Revenue Bulletin: 2010-45 -
November 8, 2010 - Series LLC
IRS issued proposed regulations regarding the classification for Federal
tax purposes of a series of a domestic series limited liability company
(LLC), a cell of a domestic cell company, or a foreign series or cell that
conducts an insurance business.
The proposed regulations provide that, whether or not a series of a
domestic series LLC, a cell of a domestic cell company, or a foreign series
or cell that conducts an insurance business is a juridical person for local
law purposes, for Federal tax purposes it is treated as an entity formed
under local law.
Classification of a series or cell that is treated as a separate entity for
Federal tax purposes generally is determined under the same rules that
govern the classification of other types of separate entities.
The proposed regulations provide examples illustrating the application of
the rule.

31. Foreign Captives
• A Foreign Captive pays US Income Taxes.
– Sec. 953(c)(3)(C) and(d) election
• If the Captive is an offshore domiciled insurance
company a Sec. 953(d) election to be taxed as a US
Insurance Company may be made. It has these
advantages:
– Captive is NOT a Controlled Foreign Corporation
– US tax rates for Insurance Companies are as low as 15%
– No Federal excise Tax, Pass-through of income or Branch Profits
Taxes
– Captive becomes a U.S. domestic corporation for all purposes of
the U.S. tax code
– Captive files U.S. tax return and pays income tax (Form 5471 no
longer required for shareholders)
– Eliminates U.S. trade or business concerns

32. Estate Planning Opportunities
• Initial Presumptions:
– The fundamental presumption in captive insurance planning is that the
client has substantial non-tax insurance needs that can be satisfied by a
captive without regard to any potential tax benefits.
– Thus, captives must serve a valid business purpose and should provide
significant cost savings.
– The following discussion only outlines the potential ancillary estate
planning benefits of a captive formed for substantial non-tax casualty, loss
and liability purposes.
– The discussion assumes that the captive is formed properly and operated
and is respected as an insurance company for federal tax purposes and
that premiums paid to the captive are arm‟s length and determined in
accordance with proper underwriting standards.

33. Estate Planning Opportunities
Family Creates and funds
Dynasty trust
Trust Client
Independent
Trustee Build up in value
benefits trust. Unused
Trustee uses trust funds reserves can be
to create and capitalize distributed to trust as
captive as sole owner dividends.
Captive
Client Company
Pays premiums
to captive (deductible; not
subject to gift tax)

34. Estate Planning Opportunities
• Potential Transfer Tax Benefits:
– Reasonable premiums paid by the insured to the captive should not create
gift, estate or GST tax exposure to the insured‟s owner.
• The premiums, however, must constitute full and adequate consideration for
insurance coverage (e.g., arm‟s length and determined in accordance with
underwriting standards).
– When the insured‟s actual claims are less than actuarially predicted, the
captive‟s reserves will grow.
• If family members directly or indirectly own shares in the captive (e.g., through
the dynasty trust structure), they benefit from this increase in value without any
transfer tax liability.
• In addition, the captive can distribute unused reserves to the captive
shareholders (e.g., the dynasty trust) as a dividend (currently taxed at capital
gains rates) or as a capital gain distribution upon complete liquidation of the
captive.
• The trust can distribute the income, if needed, for the trust beneficiaries.

35. Why CBIZ
• CBIZ MHM has both the insurance expertise through
its Employee Services (which includes our Property and Casualty
professionals as well as the tax and accounting expertise to provide
clients with fully integrated and seamless captive insurance
services that are truly “turn-key”
• Courtney W. Claflin joined CBIZ in January 2011. He has a 28 year
career in Commercial Insurance Sales and has successfully designed
hundreds of Alternative Risk Arrangements
• Courtney brings with him a team of specialists to further CBIZ‟s
expertise in the captive insurance area.

36. Summary/Key Takeaways
• Captive insurance solutions provides mid sized
companies the benefits of maintaining underwriting profit
in its group, control over risk management matters,
control over claims management, thus creating potential
significant savings in its costs of insurance
• Captive insurance provides mid-sized companies with
flexibility in ownership thus allowing potential estate and
wealth preservation opportunities
• CBIZ can provide a seamless, turnkey captive insurance
solutions due to its expertise in (i) insurance tax and
accounting and (ii) property and casualty and alternative
risk

37. QUESTIONS?

38. CBIZ MHM, LLC Contacts
Stuart Anolik
Managing Director
 301.951.3636  sanolik@cbiz.com

39. Thank You