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Captive Insurance Presentation

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Captive Insurance Presentation

  1. 1. An Introduction to CaptiveInsuranceF. Hale Stewart, JD, LLM, CTEP, CWM,CAMAuthor of the book U.S. CaptiveInsurance LawCaptiveinsuranceinfo.com832-330-4101
  2. 2. Who Should Form A Captive? A company that has an above-average risk profile. A company or individual with the financial resources to contribute to the captive. Finally, a company should have a good combination of income and risk ◦ Ideally, a company should have $3 million in gross revenue ◦ But a company that has $1-$3 million may have enough risk to warrant looking at a captive. ◦ Please call if you have questions
  3. 3. What Companies Are MoreLikely to Benefit From aCaptive Doctors and other professionals Manufacturers Exporters and Importers Dry Cleaning Construction Related Professions ◦ Contractors ◦ HVAC ◦ Plumbing Oil and Gas Hotels, Motels, Restaurants and Inns Transportation Companies
  4. 4. What Are the Benefits ofForming A Captive? Custom Insurance Policies  The Beech Case  Using Individual loss experience in determining insurance rates Gives the insured negotiating leverage with third party insurers  Third party insurer insures standard risk  The captive underwrites specialty risk Captives can be used as wealth transfer vehicles Small Insurance Companies are Taxed Advantaged  831(b)
  5. 5. What Are the Benefits toForming a Captive, con’t? Underneath the insurance and risk management purposes of a captive insurance company is a great tax arbitrage opportunity.  In the current year, the insured lowers his taxable income through the payment of insurance premiums. In forming the captive, the insured is most likely insuring a large amount of risk which was previously “self-insured,” meaning the insured paid for losses out of current earnings and savings.  The premiums are placed into a tax-advantaged vehicle – remember that small insurance companies are taxed on their current portfolio income rather than their current earnings.  When the insured sells his captive shares, the transaction is taxed as a capital gains transaction rather than as an ordinary income transaciton.
  6. 6. What Are the Steps to Forminga Captive?After a company decides to form a captive, the next step is to perform a feasibility study, which has three objectives.  It provides a blueprint for the entire captive program.  Second, it aids in compliance.  Third, the study can aid in selling important decision-makers within the organization on the plan.
  7. 7. What Are the Steps to Forminga Captive? The jurisdiction where the captive is being formed must determine if forming the captive is in the jurisdiction’s best interest. To do that, they will consider ◦ (i) The character, reputation, financial standing and purposes of the incorporators; ◦ (ii) The character, reputation, financial responsibility, insurance experience and business qualifications of the officers and directors; and ◦ (iii) Such other aspects as the commissioner shall deem advisable.
  8. 8. What Are the Steps in Forming aCaptive, con’t Next, the applicant must make a formal application to open an insurance company. The application must typically contain the following information  (A) The amount and description of its assets relative to the risks to be assumed;  (B) The adequacy of the expertise, experience, and character of the person or persons who will manage it;  (C) The overall soundness of its plan of operation;  (D) The adequacy of the loss-prevention programs of its parent, member organizations, or industrial insureds, as applicable; and  (E) Other factors considered relevant by the commissioner in ascertaining whether the proposed captive insurance company will be able to meet its policy obligations Finally, there is the issue of original capital and surplus.
  9. 9. Running the CaptiveDomicile managerLegal counselAuditActuarial ServicesInvestment manager
  10. 10. Shutting Down the Captive In most states, one of the following seven reasons will allow a state regulator to shut down a captive: ◦ 1. Insolvency or impairment of capital and surplus. ◦ 2. Refusal or failure to submit an annual report … or any other report or statement required by law or by lawful order of the director. ◦ 3. Failure to comply with the provisions of its own articles of incorporation, bylaws or other organizational document. ◦ 4. Failure to submit to an examination or any legal obligation related to the examination. ◦ 5. Refusal or failure to pay the cost of an examination. ◦ 6. Use of methods that, although not otherwise specifically prohibited by law, render its operation hazardous or its condition unsound with respect to the public or to its policyholders. ◦ 7. Failure otherwise to comply with the captive statute.
  11. 11. The IRS Fought CaptiveInsurance For Nearly 30Years They used three arguments The Economic Family Nexus of Contracts Assignment of Income No Court Accepted Any of the IRS’ arguments
  12. 12. Safe Harbor Guidance, Part IUnder Harper, a captive must comply with a three prong test: (1) whether the arrangement involves the existence of “insurance risk”; (2) whether there was both risk shifting and risk distribution; and (3) whether the arrangement was for “insurance” in its commonly accepted sense. The duck test – does the company “walk and talk” like an insurance company?
  13. 13. Safe Harbor Guidance, Part II The IRS has issued several Revenue Rulings that provide further safe harbor guidance A captive must derive at least 50% of its insurance revenue from a non-parent. ◦ Harper lowers this amount to 30% ◦ This is accomplished through reinsurance Or, a captive must have at least 12 subsidiaries in order to have sufficient risk distribution.
  14. 14. Private Letter Rulings, or, theUltimate Safe HarborA Private Letter Ruling (or PLR) is "issued for a fee upon a taxpayers request and describes how the IRS will treat a proposed transaction for tax purposes."Private Letter Rulings create certainty – we know how the IRS will view a specific transaction
  15. 15. The Law Offices of Hale Stewart Approved Utah Captive Manager Start-up costs are usually between $25,000 - $50,000 Ongoing fees are usually between $15,000 and $20,000  These fees do not include reinsurance, risk distribution or accounting fees