Captive Insurance Company

Transcription

1 Captive Insurance Company Captive Insurance Companies (referred to as Captives) and also known as Closely Held Insurance Companies (CHIC), have become a commonplace form of alternative risk transfer and can provide companies with significant insurance program flexibility and cost savings. Captives provide an additional layer of asset protection for the business that the commercial insurance market often cannot provide. In addition, when structured properly, insurance coverages that a business may purchase from a Captive can allow an operating business to take a current year income tax deduction for the amounts paid to the Captive that are used to pay future insurance claims. The business owner pays premium for the insurance coverage on an annual basis based upon an actuarial review of the unique risks of the business. Introduction to Captive Insurance Companies A Captive provides an opportunity to strengthen your risk management program. A Captive is a licensed insurance company that is separate from your operating business. The Captive can be owned by you or your family members directly or by an entity controlled by you or your family members. Coverage provided by a Captive can supplement or replace traditional property and casualty insurance. When selecting a jurisdiction to form a Captive, it is important to consider the stability, flexibility and experience of the jurisdiction s regulator. Regulators in offshore jurisdictions generally focus on sustainability, rather than strict capitalization requirements (e.g., some U.S. states require minimum capital of $1M or more) when reviewing an insurer s capital, surplus, and reserves, and the amount and type of assets that can be used to capitalize the Captive. However, a number of U.S. jurisdictions have laws and are more favorable for smaller start-up insurance companies and regulators who review the totality of circumstances when regulating small and mid-size insurance companies. If the Captive is formed offshore, there is no requirement that the assets contributed to form the Captive be moved offshore or be placed in control of an offshore person. In fact, the assets of all Captives managed by Captive Management, LLC remain in the United States. It is important to note that Captive Management, LLC is not a tax or legal advisor and that you must review participation in a captive with your tax and legal advisors. We will however note that in general, the offshore Captives managed by Captive Management, LLC elect to be taxed as a U.S. insurance company under the U.S. Internal Revenue Code (I.R.C. 953(d)). Additionally, there is a significant alternative tax benefit available to certain small insurance companies under I.R.C. 831(b). If the net written premiums received by the Captive do not exceed $1.2 million per year, then I.R.C. 831(b) allows the Captive to elect to be taxed on its investment income only and not on its insurance underwriting income. For example, if the Captive takes in $1.2 million in net premiums in a year, and it pays $100,000 in losses that year, its $1,100,000 underwriting gain for that year is not taxed; only the investment income it earns on its capital, reserves, and surplus is taxed. Furthermore, insurance companies do not pay state income taxes, unless they conduct business in a particular state; however, some states do impose premium taxes (generally ranging between 2-5% of premiums), which you would need to review with your tax advisors. Assets held by the insurance company can be well protected from the claims of creditors of the

2 insurance company s owner or owners by proper structuring of the ownership, and by virtue of the fact that any such creditor would have to deal with the insurance regulators in the insurance company s jurisdiction in order to reach those assets. Most insurance regulators would be reluctant to allow insurance company assets to be reached in this manner. What is the structure of the Captive? A Captive will be established for you and you will determine who owns the Captive. There are numerous options for who will own the Captive. The Captive is a separate legal entity established by the business owner to meet the insurance, risk management, and asset protection needs of the business. Most often, the Captive will be taxed as a C Corporation and files a United States tax return under the captive insurance taxation regulations. If there is less than $1.2 million of premium written then the Captive will be taxed only on its investment income under section 831(b). The amount of available risk for the business determines the amount of premium that is allowed in each Captive. An actuarial study completed by an independent actuarial firm will determine the maximum amount of allowable risk in the Captive. Investment growth inside the Captive is taxed at C Corporation tax rates. This tax may be deferred with the use of deferred investments such as municipal bonds and reduced with tax efficient investment portfolios. How Much Capital is Required to Establish a Captive? There are two considerations with regard to capital. The first consideration is to satisfy the capital requirement of the insurance regulator. The amount established to meet these regulatory requirements is the greater of $50,000 or 20% of the initial premium as a capital contribution. The capital and premiums are both owned indirectly by the owner through the Captive. These funds are held to satisfy the ability to pay a claim and capital requirements. The second consideration is the amount the IRS deems adequate capital. There is published guidance from the IRS with ranges of percentages that are acceptable and this is something that you and your tax advisor need to review to ensure that your Captive is adequately capitalized. What Types of Insurance are Available? The Captive provides a variety of coverages for your business. Some of these coverages will either replace or augment your existing coverages and there are probably additional coverages that your business has been seeking will be available as well. Captive Management, LLC will provide a Captive Insurance Coverages Questionnaire to assist you in determining coverages for your Captive, however, you may elect to include other lines of coverage based on the unique risks of your business. Where are the Assets of the Captive held? All assets of Captives that are managed by Captive Management, LLC are held in the United States and all of the assets of the Captive will be held in the name of the Captive. We will explain the allowable investment options under the Captive s jurisdiction and will assist the Captive and its owner in selecting appropriate investment allocations, objectives and management of assets.

3 What Kind of Business Works for a Captive? The typical profile of a business that owns a Captive is an operating business with annual sales of $1,000,000 or more a year, and employees other than the owners of the business. Passive businesses such as real estate holding companies, limited partner oil well partnerships and income from royalties do not typically have sufficient risk for a Captive. How Long Should I Remain an Owner? The typical time horizon for owners of captive insurance companies is five years or longer. The average owner stays in the Captive for ten or more years. How does the IRS define a Captive Insurance Company? To qualify as an "insurance company" for tax purposes, a Captive must satisfy several requirements. The following outlines some of the more significant aspects: a. The IRS requires that the company be in the business of issuing insurance contracts. The term "insurance contract" is not defined in the I.R.C. or the regulations. However, in Helvering v. LeGierse, 312 U.S. 531 (1941), the Supreme Court held that insurance involves risk shifting and risk distributing. Thus, an insurance contract must shift the risk of loss from the insured to the insurer and the risks retained by the insurer must be well distributed among numerous insureds. b. In order to reach an adequate level of risk shifting and risk distribution, the IRS safe harbors require a number of characteristics, but primarily focus on (1) whether a substantial portion, greater than 50%, of the covered risks of the insurer come from unrelated insureds; or (2) where the insureds are related to the insurer through common ownership, whether the premium payments are distributed among a dozen or more insureds, with no one insured paying more than 15% of the total premiums. The insurance company s premiums and reserves must be based on actuarial calculations. Simply declaring an arbitrary amount for annual premiums is not permitted, nor is basing premiums on industry averages or standards without using the services of an actuary. As mentioned on many occasions, Captive owners and participants should review all tax matters with their independent tax and legal advisors. How Does Risk Shifting and Risk Distribution Work in a Captive? The safe harbor risk shifting in the Captive is 51% of the risk. This means that the company with the claim bears 49% of the claim and the remaining 51% is allocated among all of the Captive owners in proportion to their premium for the year of the claim. Insurance companies manage their risk based upon the coverage offered, the amount of coverage that is available for each coverage and the size of the risk pool. As premiums increase in a risk pool there is more risk spread among the Captives, if premiums decrease there is less risk to spread among the Captives. If the company and the insurance program are structured properly, the following potential benefits are available: 1. Lower insurance costs through designing proper coverage limits, elimination or reduction of broker commissions and lower administrative costs.

4 2. The Captive can design the coverage that applies to the needs of the company and structure the policy accordingly. 3. Asset protection from the claims of business and personal creditors. Captives can provide coverage for risks not available or too expensive in the traditional marketplace. 4. The insurance company will not be subject to income taxes on its underwriting income under section 831(b). 5. The insurance company will not be subject to state income taxes depending upon the domicile of the Captive. As mentioned on many occasions, Captive owners and participants should review all tax matters with their independent tax and legal advisors. What are the Cost Structure, Procedures and Services Offered for Establishing a Captive through Captive Management, LLC? Initial Analysis We will perform an initial analysis of your business to determine if your business qualifies for a Captive at no cost. You must complete the questionnaire and provide the information requested for this service. Feasibility Study After the Initial Analysis is completed and you are ready to move forward, a feasibility study is completed. This includes an analysis of the most recent tax return and the current year financials combined with analyzing the risks of the business. The cost of the feasibility study is typically $3,500. If your situation requires a larger fee we will notify you prior to beginning the study. This is a one-time nonrefundable fee that is applied to your Establishment Cost, below. Establishment Cost - Typically 6% of anticipated annual premiums which includes: Feasibility study Incorporation costs by an independent trustee for the owner. Each Captive is a separate legal entity with no other owners and is established as a C Corporation. Initial filing fees for the insurance regulator Establishment and registered agent costs for the establishment of the LLC that will hold the cash and investments of the Captive Initial insurance manager fees for the establishment of the Captive Initial accounting and supporting services Initial paperwork requirements for the establishment of the Captive in your jurisdiction Initial insurance license for the Captive Initial business company license fee Any other related costs for the establishment of the Captive

5 Annual Management Cost Structure - There is an annual management fee which is typically 7% of annual premium with a minimum of $8,500 to cover the operating expenses of the Captive. This cost is based upon the annual contribution of premium. The cost is not based upon cumulative premiums. The fee is due upon establishment and January 1 of each year. The services include: Actuarial analysis by independent actuary Analysis of coverage information and insurance coverage selection to owner Annual insurance policy issuance Claims analysis and processing Annual insurance manager fees Annual insurance license fees Annual director fees Annual business company license fee Annual fees for the insurance regulator and other related costs Annual audit of the pooling company Annual corporate tax return preparation (1120-PC) and Annual Report in accordance with insurance reporting requirements prepared by independent CPA (which must be reviewed by owner s tax preparer). The owner of the Captive signs the annual tax return. Annual accounting services for your Captive Annual paperwork requirements for the maintenance of the Captive Annual LLC filing fees and registered agent costs for the LLC that will hold the cash and investments of the Captive Annual insurance license for the Captive Support for questions that you have regarding the management of the Captive Captive Management, LLC provides management services for the Captive. For more information please contact us today at. This document is for educational and informational purposes only. Captive Management, LLC does not provide legal or tax advice. Captive owners and participants should review all tax matters with their independent tax and legal advisors. Any U.S. federal tax information contained in this communication (including any attachments) is not intended to be used or relied upon for the purpose of (i) avoiding taxes or penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending any transaction or matter addressed herein. Any tax related information must be reviewed with your independent tax advisor. Captive Management, LLC is not affiliated with First Allied Securities, Inc or Financial Directions Group