The Rise of Captive Insurance Companies: Are They also an Opportunity to Address Obamacare?

Transcription

1 The Rise of Captive Insurance Companies: Are They also an Opportunity to Address Obamacare? Moderator: Ken Levinson, Partner Faegre Baker Daniels Jeff Brimer, COO Alexius, LLC Kaya Bromley, General Counsel Freedom Care Benefits

2 Presenters Jeff Brimer COO Alexius, LLC (720) EXT 101 Kaya Bromley General Counsel FreedomCare Benefits (248) Ken Levinson Partner Faegre Baker Daniels

3 What Is A Captive And How Does It Work? Captives are fully licensed, fully regulated, private insurance companies Domiciled (formed and regulated) in a US state (or D.C.), or foreign country Owned by corporation as a parent owned captive, or by a group or industry, to insure specified risks Requires arms-length pricing on premiums paid by insureds to the captive Frequently will insure deductibles or uninsurable risks under commercial programs; a cash funding arrangement to assure assets available in future to pay claims May use a front, such as utilizing the pre-existing licensing/registration of a commercial carrier (and then reinsure the specified risks into the owned captive) Captives can access reinsurance markets (only accessible by insurance company ) (c) 2015 Faegre Baker Daniels LLP.. 3

4 What Is A Captive And How Does It Work? (cont.) Requires capital from the owner(s) and appropriate premiums to cover risks, and provide reserves, per regulatory requirements (such as 3:1 ratio) Tax Benefits (non 831(b) ): can accelerate deductions for insurance reserves before claims are paid out; no state income tax on investment earnings or underwriting profits Tax Benefits of an 831(b) captive: smaller size insurer, premiums paid are still tax deductible, may not receive more than $1.2MM in premiums annually, taxed only on its investment income Tax Costs: must pay prescribed state premium taxes (if domestic captive) If foreign domiciled captive, must consider application of US Subpart F (CFC) rules and exposure to federal excise tax on premium payments (c) 2015 Faegre Baker Daniels LLP.. 4

5 Business Issues Relating to Captives What are business objectives and expected benefits from captive? What insurance risks are appropriate for the captive? Traditional uses include highly predictable coverages/deductibles (e.g., workers comp, auto liability, general liability, etc.) Nontraditional, customized or volatile risks may also be written Strategic integration with commercial insurance program Continuing evaluation of potential flexible uses of captive to respond to changes in the commercial insurance market, available lines of coverage, or exclusions When should the agreed risks be written by the captive? Apply a crawl, walk, run staged approach, or a more accelerated timetable based on business needs or market conditions? How to utilize benefits of captives? What kind of captive is most appropriate, and where is it to be domiciled? (c) 2015 Faegre Baker Daniels LLP.. 5

6 Captive Tax Issues (cont.) I.R.S. Rulings and Structuring Considerations Three Revenue Rulings in late 2002 established general principles to determine tax qualification of certain captive insurance companies IRS Rulings control interpretation and audit results by IRS agents Rulings addressed 25 years of interpretative disputes with taxpayers The 2002 Rulings covered three types of captives: Parent/Subsidiary Captives (captive insures risks of its parent and, perhaps, unrelated risks) Brother/Sister Captives (captive insures risks of its commonly-owned brother/sister affiliated companies, not its parent) Group Captives (captive insures specific, common risk(s) of a group of unrelated owners) (c) 2015 Faegre Baker Daniels LLP.. 6

7 I.R.S. Rulings and Structuring Considerations Key common principles established in 2002 (and subsequently reinforced) by the IRS for captives to qualify for Federal tax benefits: All premiums must be pooled by the captive; all assets (premiums, reserves, surplus) must be available to pay all risks being insured Captive cannot loan funds to its parent, owner(s) or insureds No parent or insured can guarantee the captive s performance Additional requirements for qualification as an insurance company : Adequate risk shifting and risk distribution; requires that a loss by one policyholder is not borne in substantial part by such insured s premiums Captive must still meet business purpose, administrative/regulatory requirements, arms-length pricing, adequate capitalization, proper documentation, etc. (c) 2015 Faegre Baker Daniels LLP.. 7

8 Example of Captive Structure Parent Corp. Parent Risks Third Party Risks Subsidiary 1 Subsidiary 2 Captive Risks from Subsidiaries Possible Reinsurance / Stop Loss Reinsurer (c) 2015 Faegre Baker Daniels LLP.. 8

9 Example of Franchise Captive Structure Franchisor Opportunities Franchisor Owner Franchisor Corp. Parent Risks, Deductibles Fronting Insurer Franchisee 1 Owned Stores Subsidiary Subsidiary/Stores Risks, Deductibles Captive Reinsurance into captive Risks, Deductibles from Franchisees Franchisee 2 Franchisee 3 Franchisee 4 Possible Reinsurance / Stop Loss Reinsurer (c) 2015 Faegre Baker Daniels LLP.. 9

10 Some Factors in Domicile Selection Domestic Incorporated entity, formally licensed/regulated by state regulators If corporation-owned captive, should be included in group s consolidated financial statements (subject to confirmation by auditors) and Federal tax consolidated return filing No state income tax (on captive s income, underwriting profits, investments, etc.), but premiums are subject to state premium taxes If company were to consider in future using captive for employee benefits risks, or terrorism coverage, must have a domestic captive Offshore Incorporated entity, formally licensed/regulated by foreign government regulators Generally not part of consolidated group for Federal tax purposes Not usually subject to foreign premium taxes, but other fees, licensing costs may soak up savings Subject to US Federal excise tax on premium payments to offshore insurer/reinsurer (4% or 1%, respectively), unless domiciled in favorable tax treaty jurisdiction Likely a Controlled Foreign Corporation subjecting US Shareholders to current taxation Exception to possible CFC classification: Make a US domestication election (c) 2015 Faegre Baker Daniels LLP.. 10

11 IRS Audit Activity in Captive Area Issues in Audit The arrangement doesn t qualify as insurance (too few insureds, too much concentration of risk, loan backs to parent/insureds) Compare the recent Tax Court decision in Rent-a-Center regarding the risk distribution /concentration of risk requirements in IRS rulings The captive doesn t qualify as an insurance company (inadequately capitalized, improper/unjustified premium amounts, inadequate reserving) State conformity issues (if captive doesn t qualify Federally, what is impact for State tax purposes)? FIN 48/UTP reporting positions, book and tax reserve issues Effects of Federal tax audit adjustment on multiple years How to Avoid Problems With YOUR Captive? (c) 2015 Faegre Baker Daniels LLP.. 11

12 $465 Billion 12

13 Penalty A Penalty B Catch-all Penalty 13

14 Penalty A - $2,084 Penalty B - $3,126 Catch-all Penalty ($100 Per EE Per Day) 14

15 Penalty A Example: Scalia Construction Company has 300 Full- Time Employees. Scalia does not offer insurance. One EE receives a subsidy on the exchange. What is the penalty? $2,084 x (300 80*) = $485,480 * 30 in

16 Penalty B Example: Roberts Dairy Farm has 2,000 Full Time Employees. Roberts offers insurance but the insurance does not provide minimum value. One thousand of Roberts Employees receive a subsidy on the exchange. How much is Roberts Penalty? $3,126 x 1,000 = $3,126,000 16

17 Catchall Penalty Example: C. Thomas Beverage Company has 500 Full-Time Employees. C. Thomas offers insurance but violates the 90 day rules. C. Thomas does not find out about this violation for 12 months. What is C. Thomas Penalty? 500 x 365 x $100 = $18,250,000 17

18 DOL Audit Penalties IRS Audits Lawsuits OSHA Whistleblower Actions Costs of Compliance Legal / Consulting Fees Audit Preparation Intangible Costs ERISA Violations (510) 18

19 Three Steps to ACA Compliance 19

20 Step One: Avoid Penalty A 20

21 Offer Minimum Essential Coverage To All Full-Time Employees and Dependents. 21

22 The MEC Strategy (Skinny Plans) Limit Exposure to Penalty A Is it legal? Does it mean I have no conscience? Satisfies Individual Mandate 22

23 Step Two: Avoid Penalty B 23

24 Offer Affordable Insurance that Provides Minimum Value Coverage to All Full-Time Employees 24

25 The Minimum Value Strategy Walk-Away Plans Minimum Participation What if Too Many Employee$ Accept it? (Pricing) Hedging By Also Offering MEC 25

26 Step 3 Document. Document. Document. 26

27 Why? This is how the IRS will determine: A. Employer Penalties B. Individual Penalties 27

28 28

29 Good News? Good Faith! 29

30 How to show Good Faith attempt to comply? 1. Adopt a compliant plan 2. Comply with all reporting requirements 30

31 Strategy 31

32 Satisfy Penalty A & B Reporting Compliance Compliance Guarantee Your Peace Of Mind Tax-Efficient 831(b) 32

33 FreedomCare is a Captive Insurance Company designed specifically to comply with the ACA mandates & To deliver to employers of all sizes the benefits of selfinsurance that have been enjoyed by larger companies for decades. 33

34 The Benefits of FreedomCare FreedomCare is a South Dakota Series Business Trust licensed as a captive insurance company. Simplified formation process Extremely cost effective: Formation and On-going Minimal time requirements by employer Reinsured by Lloyd's of London Every employer gets their own Cell Trust captive Each cell is its own insurance company No joint and several liability No co-mingling of assets or risk pools Potential tax benefits under IRC 831(b) 34

35 How Does The IRC 831(b) Work? For those employers who wish to take the IRC 831(b) election, these factors need to be considered: Only applies to small P&C insurance companies with less than $1.2 million in premiums. If qualified, the captive company only pays tax on investment income; any underwriting income is not taxed. Underwriting losses are also not available, even if a loss is experienced (captive will still pay tax on investment income). Note: The decision to create a captive should never be made solely on the tax benefits, and should only be made after consulting your tax advisors. 35

36 How does FreedomCare comply with the ACA? Satisfies Penalty A By offering Minimum Essential Coverage Satisfies Penalty B By offering a plan that provides Minimum Value 36

37 The Intent of the ACA INTERNAL REVENUE SERVICE Every qualifying employee gets MEC Even if they opt-out of the MVP, they will have satisfied their Individual Mandate FreedomCare differs from walk-away plans in which lower wage workers who do not qualify for Medicaid end up with nothing. With FreedomCare, they are no longer on the hook for the Individual Mandate. Meets the Good Corporate Citizen standard 37

38 Thank you! Questions? 38