Captive Insurance Issues and Trends. Michael Mead, Kyle Mrotek and Doug Youngren

Transcription

1 Captive Insurance Issues and Trends Michael Mead, Kyle Mrotek and Doug Youngren

2 What is a Captive and What Does it Do? Michael R. Mead, CPCU, M.R. Mead Co. 1

3 What It Is Not 2

4 Definition of Captive Insurance A form of self insurance in which the insured owns the insurance company. Originally done for tax reasons. When self insured one cannot take a tax deduction for reserves. Convert reserves to premium and take a deduction. 3

5 Regulation Licensed in a domicile Form of self insurance so no need for all the traditional regulations Capital, surplus, taxes, fees all set by domicile Need audit, actuarial review of reserves 4

6 Reasons to Have Tax deductions Control of risk funds Control of claims, reserves Selection of vendors Access to reinsurance 5

7 Coverage 70% write workers compensation General Liability Auto liability Crop Property Loss of Income Etc. 6

8 New Coverage Cyber Liability Reputational Risk Business Interruption Terrorism Director s & Officer s Employee Dishonesty Employment Liability 7

9 Types of Captive Single parent, Pure Group/association Cell Risk retention group 8

10 Much has changed Over 50% of the commercial property/casualty market is in some form of self insurance. Over 6000 captives in existence. Very popular with estate planners and wealth management advisers. 9

11 831(b) Specific section of IRS code, not a form of captive If otherwise an insurance company and premiums under $1.2 million, no tax on profits Investment returns taxed Losses can t be deducted Must be an insurance company in all ways 10

12 Current challenges Promoted in writing as a tax device Put together by non-insurance people Lack actuarial feasibility study Lack business plan Lack insurance purpose 11

13 Costs $50,000 to set up Actuary: $15,000 +/- Consultant: $15,000 Attorney: $5,000 Taxes, fees: $8,000+/- Capital: $250,000 + $75,000 ONGOING Actuary: $15,000 Manager: $40,000 Accountant: $15,000 Taxes, Fees: $8,000 12

14 Steps to Form Engage consultant Engage actuary/needs 5 years of losses, premiums Write business plan(consultant) Complete application Fund (amounts from statutes, actuary) 13

15 Captive Insurance QUESTIONS? Michael R. Mead, CPCU, President M.R. Mead & Company

16 Captive Insurance Tax Planning Doug Youngren, CPA, Plante Moran 15

17 What is Insurance? Risk Shifting and Risk Distribution The tax definition of insurance is based on judicial principals first discussed in Helvering v. LeGierse, 312 U.S. 531 (1941) Economic Family Doctrine SEE HUMANA, HCA, MALONE & HYDE REV. RUL entity safe harbor LIMITATIONS ON Economic Family Doctrine REV. RUL , IRB 4 (LOOK THROUGH SINGLE MEMBER LLC, BUT NOT MULTI-OWNER LLC) PLR , TAM (RISK ATTRIBUTED TO GENERAL PARTNER) 16

18 What is Insurance? Risk Shifting and Risk Distribution Third-party business See HARPER GROUP, ODECO 50% Safe Harbor - REV. RUL , IRB 984 Sources of Unrelated Business CUSTOMERS, e.g., EXTENDED WARRANTY (SEE PLR ) EMPLOYEE COVERAGES (e.g., H.O., AUTO, UMBRELLA) EMPLOYEE BENEFITS, SEE REV. RUL , C.B. 45 MEDICAL STOP LOSS (?), REV. RUL , IRB 1 17

19 What is Insurance? Risk Shifting and Risk Distribution Unrelated Business Pooling Arrangements Concentration of Risks REV. RUL , IRB 4 REV. RUL , IRB

20 What is Insurance? Other Issues Premiums were not for insurance Retroactive Insurance, e.g., REV. RUL Imbedded Warranty Residual Value Insurance TAM , RVI GUARANTY COMPANY LTD. ENTERPRISE RISK Fortuitous Events 19

21 What is Insurance? Recent Case Law Rent-A-Center v. Commissioner, 142 T.C. 1 (January 14, 2014) Dividend opinion in favor of taxpayer Deduction for premium was allowed for all amounts paid by subsidiaries deduction for premium paid by parent was disallowed Big Three Coverages: Workers Compensation, Auto Liability, General Liability 15 Affiliates were covered with largest accounting for 65% of premiums paid 20

22 What is Insurance? Rent-A-Center v. Commissioner IRS focuses on the business practices of the Captive Guaranty of Deferred Tax Asset Guaranty/Keepwell by Parent Purchase of Treasury Stock of Parent subject to a Put 21

23 What is Insurance? Rent-A-Center v. Commissioner Majority opinion agreed with 6th Circuit in Humana Guaranty was by parent, not by insureds Guaranty was not in favor of a third party Guaranty amount was small Majority opinion focused on exposure units that were statistically independent risks 22

24 What is Insurance? Rent-A-Center v. Commissioner Dissent Ownership of parent s treasury shares by the Captive were an issues if the parent was insolvent the put would not have been enforceable There was no shifting of risk because of the parent s guaranty and low capitalization Assets did not create income Will the IRS Appeal? 23

25 Domestic Tax Issues Insurance Companies generally benefit from book-to-tax differences that non-insurance companies are not entitled to: Deduction for Loss reserves Modified Premium Recognition Rules Small Company Elections 831(b), 501(c)(15) 24

26 Section 831(b) Companies Operating Company Gen-1 or Gen-2 Dividends Paid (Taxed at Qualified Dividend Rates) Up to $1,200,000 in Premiums (Deductible at Ordinary Tax Rates) Captive Insurance Company (831(b) Election) Losses & Fees Paid from Premiums 25

27 Section 831(b) Companies What is an 831(b) election? Premiums must be less than $1,200,000 (greater of direct or net written) Multiple micro-captives may be formed if there is no attribution between them Must qualify as an insurance company Underwriting Income is not taxed Election is irrevocable without IRS consent NOL carryovers/carrybacks lost Income Tax Benefits Tax free income Tax rate arbitrage ordinary rates for deductions, qualified dividend rates for income Possible Wealth Transfer Structure Nature of Risk must be addressed Change in branch Consider IRS positions in PLRs , ,

28 Protected Cell Companies BACKGROUND Preferred Status Participation Agreement Independently incorporated Cells are generally Bankruptcy Remote from other cells and from the General Account GENERAL ACCOUNT CELL 1 CELL 2 CELL 3 CELL 4 CELL 5 CELL 6 27

29 Protected Cell Companies Deduction for Premiums Paid Rev Rule in general, individual cells may be treated as if it were a separate captive insurance company Brother/Sister Unrelated Business test 28

30 Protected Cell Companies Taxation of Cell Companies Proposed Regulations (REG ) issued in 2009 Domestic cell companies (or series LLC companies) will generally be treated as separate companies Foreign cell companies (or series LLC companies) will generally be treated as separate companies 29

31 Captive Insurance For Established Closely Held Insurance Companies Basic Structure Assumptions: 1. Insurance Company with underwriting profits 2. Currently being reinsured with unrelated reinsurer 3. Insurance company owned by older generation 4. Younger generation consists of 4 adult children Plante Moran 30

32 Current Structure Insurance Company Owned by Father Unrelated Reinsurer 31 Plante Moran 31

33 With Insertion of 831(b) captives Insurance Company Owned by Father 831(b) owned by one adult child ($1,200,000 of Premiums) 831(b) owned by one adult child ($1,200,000 of Premiums) 831(b) owned by one adult child ($1,200,000 of Premiums) 831(b) owned by one adult child ($1,200,000 of Premiums) Unrelated Reinsurer Plante Moran 32

34 The Family Attribution Rules Under 831(b) The tax rules state that one type of controlled group that causes the premiums of the Parent insurance company to be combined with the 831(b) captives is the Brother- Sister controlled group the definition of which is as follows: Two or more corporations if 5 or fewer persons who are individuals, estates or trusts own stock possessing more than 50% of the total value of shares of all classes of stock entitled to vote or more than 50% of the total value of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent that such stock ownership is identical with respect to each such corporation. Plante Moran 33

35 How is the 50% Determined? Brother Sister Controlled Group Individuals Corporate Ownership % X Identical Ownership A B C D E F G H I J Total Y 34 Plante Moran 34

36 What are the Family Attribution Rules? An individual is treated as owning all of the stock of his spouse as well as his children who have not attained the age of 21 If an individual is treated as owning more than 50% of the stock of a corporation as a result of the above rule then that individual will be treated as owning all of the stock of his parents, grandparents, grand children and children who have reached 21 years of age Plante Moran 35

37 Other Items to Consider Lower frequency and higher severity risks are more suitable for this type of structure because they allow for a more tax efficient build up of surplus Normally best suited to short tail lines of business(such as property risks) Other ownership structures create problems because of attribution rules 36 Plante Moran 36

38 Disclaimer This presentation is part of Plante Moran marketing of professional services, and is not written advice directed at the specific facts and circumstances of any person and/or entity. This presentation is not intended or written to be used, and cannot be used, for the purpose of avoiding taxes and penalties that may be imposed for any purpose or transaction. 37

39 Thank you This presentation is part of Plante Moran marketing of professional services, and is not written advice directed at the specific facts and circumstances of any person and/or entity. This presentation is not intended or written to be used, and cannot be used, for the purpose of avoiding taxes and penalties that may be imposed for any purpose or transaction. 38

40 Captive Insurance Tax Perspective QUESTIONS? Doug Youngren, CPA, JD, Tax Partner

41 Captive Insurance Actuarial Perspective Kyle Mrotek, FCAS, MAAA, The Actuarial Advantage 40

42 Captive Insurance Actuarial Perspective 41

43 Captive Insurance Actuarial Perspective Critical to operation of captive insurers promise to pay Ultimate cost of insurance not known at time of sale Actuarially sound pricing/reserving helps ensure ability to pay 42

44 Captive Insurance Actuarial Perspective Actuary Overview Captive Feasibility Closing 43

45 Captive Insurance Actuarial Perspective Actuary Overview 44

46 Actuary Overview Trivia Actuary is noun, Actuarial is adjective Edmund Halley, formed basis of actuarial profession Head count Location Lawyers CPA s FCAS s USA 1,268, ,216 3,392 Illinois 62,496 23,

47 Actuary Overview Qualifications Four general areas of practice & designation Life/Health/Pension Fellow, Society of Actuaries (FSA) Property/Casualty Fellow, Casualty Actuarial Society (FCAS) Seek appropriately qualified for captive s exposures Most captives are property/casualty seek FCAS Many are including medical seek FSA with health specialty Independent 46

48 Captive Insurance Actuarial Perspective Captive Feasibility 47

49 Captive Feasibility Overview Purpose Is a captive insurance company right for your company? If yes, how to pursue optimally? Content Financial evaluation Operational evaluation Actuarial analysis 48

50 Captive Feasibility Captive Actuarial Feasibility Info Required Proposed coverages and policy provisions Historical loss experience Historical & prospective exposures 49

51 Captive Feasibility Captive Actuarial Feasibility (continued) Premium for Fraud Loss Reimbursement Insurance (1) % of Revenue Lost to Fraud 5% (2) Annual Revenue $7,500,000 (3) Loss Cost-Uncapped $375,000 (4) % Loss Cost Allocated to Policy (5) Loss Cost-Capped $130,000 (6) Estimated Premium $200,000 (1) Association of Certified Fraud Examiners, 2014 Global Fraud Study (2) Insured's pro jected annual revenue (3) = (1) * (2) (4) Estimated from ACFE size of loss chart (5) = (3) * (4), rounded (6) = (5) / 0.65, rounded 50

52 Captive Feasibility Captive Actuarial Feasibility (continued) Basic Results Actuarially fair premium Projection of loss and loss expense Policy Year 2015 Coverage Written Premium Ult Loss & Loss Exp Coverage A $500,000 $325,000 Coverage B $400,000 $260,000 Coverage C $200,000 $130,000 Sum $1,100,000 $715,000 51

53 Captive Feasibility Captive Actuarial Feasibility (continued) Basic Results Expected Scenario Loss and Loss Expense Payout Loss and Loss Expense Payout Policy Year Written Premium Ult Loss & Loss Exp ,100, , , ,250 71,500 35, ,122, , , ,395 72,930 36, ,144, , , ,540 74, ,167, , , , ,190, , ,450 Sum 5,723,000 3,719, , , , , ,058 52

54 Captive Feasibility Captive Actuarial Feasibility (continued) Basic Results Adverse Scenario Loss and Loss Expense Payout Loss and Loss Expense Payout Policy Year Written Premium Ult Loss & Loss Exp ,100, , , ,250 71,500 35, ,122, , , ,395 72,930 36, ,144, , , ,540 74, ,167,000 1,750,000 1,750, ,190, , ,450 Sum 5,723,000 4,711, , , ,415 1,970, ,275 53

55 Captive Feasibility Captive Actuarial Feasibility (continued) Additional Results Pro Forma Financials Evaluate Capitalization PY 2018 adverse loss increases solvency ratios NPW:Surplus (Exp) NPW:Surplus (Adv) Res:Surplus (Exp) YE '15 YE '16 YE '17 YE '18 YE '19 Res:Surplus (Adv) 54

56 Captive Insurance Actuarial Perspective Closing 55

57 Closing Number of Captives ROW US

58 Captive Insurance Actuarial Perspective QUESTIONS? Kyle Mrotek, FCAS, MAAA, Consulting Actuary The Actuarial Advantage, Inc