Go Big or Go Home! IND002

Transcription

1 Captive Industry Session Go Big or Go Home! IND002 Speakers: Wednesday, April 13, :00 a.m. 11:00 a.m. Dennis P. Harwick, President Captive Insurance mpanies Association Michael Scott, Vice President Insurance and Risk Management Archer Daniels Midland mpany Anne Marie Towle SVP and Senior Captive nsultant Willis Towers Watson Global Captive Practice Charles Chaz Lavelle Partner Bingham Greenebaum Doll, LLP

2 Learning Objectives At the end of this session, you will: Learn ways that other captives have gone big. Learn how to increase the functionality of your captive within your organization. Learn what the hot topics are for the captive industry and the tools to best respond to those issues.

3 Captives: Go Big or Go Home! The Captive Landscape Session Overview Who are these people and what are they going to tell you?

4 Captives: Go Big or Go Home! Michael Scott ADM Case Study

5 Increasing the Functionality of a Captive to your Organization

6 An Evolving Risk Financing Strategy Why do mpanies use Captives? ntrol Management of claims Program design verage Fill coverage gaps Exclusions for difficult risks Capacity Access to reinsurance Captive Strategic enabler mpliance Legal and tax certainty Premium allocation st Leverage the market mmercial Affinity programs Extended warranties

7 Examples Business Purpose An Evolving Risk Financing Strategy Utilization Models and Business Purpose Retained Risk Finance Risk Transfer Rate Arbitrage Access to Capacity 3rd Party Utilizations Governance around retained risks Enhancing risk management efforts Better use of capital to retain risk than transfer Harmonization risks across global portfolios Accelerating tax treatment of retained liabilities Reducing cost of risk transfer Reinsurance market cost of risk transfer is less than commercial retail cost of risk transfer Managing total cost of risk Recapturing Ceding mmission Transferring risk to alternative forms of capacity, which may not be otherwise accessible in commercial retail market Accessing profitability imbedded in insurances sold to affiliates / consumers/ partners Creating stickiness for core product offerings Further penetration into consumer / partner / affiliate wallets Deductible buy-down programs Participation in excess programs Fronted global programs Multinational benefit pooling Reinsurance pass through Excess Re placements Integrated risk programs Multinational benefit pooling ART Solutions Cat Bonds Integrated Aggregates Parametric Triggers Weather Derivatives nsumer facing insurance programs Affiliate business Agency captives Vendor Programs Franchisee programs

8 New Ventures/Entrepreneurial Utilization of Captives Vendor Programs Limits and coverage needs met Affiliate business Fill coverage gaps and aggregate risk Franchisee Programs st effective, risk oversight and profit center Affinity Programs 3 rd Party Strategic Use Warranty Capture profits Credit/Forced Placed

9 Tailored Financing Options Capital Markets Captive Options Weather Solutions Portfolio Solutions Structured Solutions Capital Solutions Non-Traditional Risk Insurance Markets

10 Opportunity Identification Internal Changes Mergers & Acquisitions, Divestitures Poor financial results/cost pressures Investor / customer legal requirements External Pressure Client moving into new activities or regions Changes in legislation, solvency requirements or accounting practices Change in Risk Manager/CFO Captive Opportunity? Fluctuations in commodity, energy or other relevant prices Increase in premium, reduction in limits (& withdrawal) or restrictive coverage under traditional placement Severe local event, e.g. terrorism, political unrest, or natural catastrophe Insurance Program New & Emerging Risks Large claim, uninsured event, claim denied or protracted claims settlement process Unseasonal weather impacting client or region Global/ Regional Events

11 Fronting Non-Traditional Risk Characteristics Custom policy wordings reflecting specific risk covered llateral usually required by fronting partner Additional risk may impact solvency requirements Current Trends Cyber Political Risks Non-damage BI Supply Chain Product Recall

12 Multi-line Stop Loss Protection mbining EB pooled risk with P&C pooled risk and stop-loss on a combined life/nonlife basis Reduces captive s maximum cross class annual aggregate exposure Premium reduction through portfolio approach Reduction of volatility Reduction in capital requirement Stabilization of underwriting result

13 Accountability within Operating Units Financial Measured Captive Safety Operational

14 Financial Performance Metrics Accountability Monthly or quarterly reporting Reward for safety measures Growth Achievable Desired? Benchmarking Internal External

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16 16 Discussion Points December 2015 Amendments to section 831(b) What hasn t changed qualifying as an insurance company for tax purposes IRS scrutiny of captives electing section 831(b) Audits and Investigations Dirty Dozen Avrahami v mmissioner Actions that unintendedly affect captives

17 Protecting America From Tax Hikes Act of Protecting America from Tax Hikes of 2015 (HR 2029) which passed December 18, 2015 included changes to section 831(b): The maximum premium is increased to $2,200,000, and indexed for inflation. The captive must meets one of two diversification tests: No policy holder pays 20% of the premiums No wealth transfer Effective for years beginning after December 31, 2016

18 Protecting America From Tax Hikes Act of 2015, cont 18 Must meet one of two: Test 1: No more than 20% from any one policy holder Premiums are the greater of net written or direct premiums Related insureds are treated as one policy holder Test 2: The spouse and lineal descendants cannot own more in the insurance company than the operating entity Examples are provided below There is a 2% de minimus tolerance for different ownership, which the IRS is authorized to change

19 19 Captive 1 Mother Daughter 70% 30% 100% ABC mpany Insurance ABC Captive 1 Because Daughter owns more in Captive* [100%] than she owns in Business [30%], Captive 1 is not eligible to make an election under section 831(b) * subject to the 2% de minimus rule

20 20 Captive 2 Mother Daughter 70% 30% 30% 70% ABC mpany Insurance ABC Captive 2 Because Daughter owns no more in Captive* [30%] than she 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

21 21 Captive 3 Mother Daughter 70% 20% 30% 80% ABC mpany Insurance ABC Captive 3 Because Daughter owns no more in Captive* [20%] than she 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

22 22 Summary of Examples Owner Business %age Owned Captive 1 Mother 70% Captive %age Owned Daughter 30% 100% Captive 2 Mother 70% 70% Daughter 30% 30% Captive 3 Mother 70% 80% Daughter 30% 20% Eligible for 831(b) Election No Yes Yes

23 23 Mutual 4 A B C D E F G H I J K L A B C D E F G H I J K L Premium-8 1/3% each insured Mutual 4 12 corporations (A., B., C., etc.) insure with a mutual insurance company. A owns A., B owns B., etc. A through L are unrelated. Each of the insureds pays 8-1/3% of the premiums. The mutual would meet the 20% diversity test because no policy holder pays more than 20% of the premiums.

24 24 Mutual 5 A B C D E F G H I J A K L B C D E F G H I J Premium-8 1/3% each insured Mutual 5 12 corporations insure with a mutual. A owns A., B owns B., etc. though J owns J. In addition to A., A also owns K. and L. Each of the insureds pays 8-1/3% of the premiums. The mutual would not meet the 20% diversity test because A., K. and L. are treated as one policy holder that pays more than 20% of the total premiums.

25 25 Open Questions The three goals of the amendments are narrow; they do not go into effect until 2017 Over the next year there may be interpretations by the IRS and people will read the statute in light of specific fact situations For 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 holders How does the relatedness apply where the next generation owns differing amounts in the operating entities?

26 26 What Hasn t Changed On 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 amendments If the captive fails to meet the new tests in 2017 or beyond, it is still an insurance company for tax purposes. The consequence will be that it is 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)

27 27 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)

28 Audits of Captives Electing Section 831(b) The audits are very exhaustive and usually include an interview of the principal(s) and comprehensive information requests 28 mprehensive information document requests: Information from the inception of the captive, even if it preceded the years under audit All s, marketing materials, etc. mprehensive 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

29 Audits of Captives Electing Section 831(b), cont. 29 mprehensive Information Document Requests (cont): What is the operating company s risk management program How 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

30 30 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 de provision. Underwriting and actuarial substantiation for the insurance premiums paid are either missing or insufficient.

31 31 Avrahami v mmissioner Avrahami v mmissioner is the first case involving a captive electing to be taxed under section 831(b) The briefs have been 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 thinks that 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.

32 Unintended nsequences? Numerous actions may affect captive even though captives are not the primary target The IRS litigation against captives that elect section 831(b) will affect larger captives as courts comment on: Definition of insurance Insurance Risk Risk Distribution Investments Pricing/Losses Regulation Policy Terms mmon Notices of Insurance

33 NAIC Actions On Captives NAIC proposed a multi-state reinsurer proposal in 2014 Enactment would have required greater regulation There was much debate about the merits On its face, the proposal would have extended to any reinsurer that reinsured risks from multiple states This would have implicated numerous captives, including almost everyone in a pool Ultimately, the language was redrafted and was narrowed generally thought to apply to XXX and A-XXX captives

34 Other Non-Captive Actions Affecting Captives Dodd-Frank Wall Street Reform and nsumer Protection Act (Dodd-Frank) -- Non-Admitted and Reinsurance Reform Act of 2010 Brokers pay all surplus lines tax to home state, rather than some to each state with insurance risks Does it apply to captives? Industry debate e.g. Vermont alition Influencing domestications, start ups and new policies? Approach of some domiciles

35 Other Non-Captive Actions Affecting Captives (2) RVI is not a captive case, but the opinion comments or at least two areas relevant to captives: Insurance risk Effect of regulatory compliance See also Rent-A-Center and Securitas Validus (no cascading of excise tax) Primarily affects commercial reinsurance, Relevant to some captive reinsurance arrangements. PFIC proposed regulation/senator Wyden Senator Wyden is concerned that hedge fund have too thin of insurance arrangements to qualify as insurance companies Proposed Reg Must have employees Not have more capital than necessary to support the insurance program