P1: PRE CONFERENCE SESSION: Introduction to Captive Insurance Monday, October 21, 2013, 3:00 pm to 5:00 pm

Transcription

1 P1: PRE CONFERENCE SESSION: Introduction to Captive Insurance Monday, October 21, 2013, 3:00 pm to 5:00 pm Kevin Doherty Partner Nelson Mullins Riley & Scarborough, LLP Christopher L. Kramer Director of Marketing Captives ULLICO 1

2 Solutions for the Union Workplace Fred Reiss HOF 2

3 The (almost very) Beginning Popularity and Awareness 3

4 What is a Captive? Definition 1960 s An insurance company formed by its parent for the sole purpose of insuring the risks of the non-insurance parent. Currently A limited purpose, licensed re/insurance company to mainly insure the risks of the captive s owners, participants, or affiliates. Sham or Insurance Company* *The IRS does NOT define insurance. Captives insure and manage risk so they must qualify as an insurance company to obtain primary benefits of (1) premiums paid into it as bona fide business expenses (for policyholder) and (2) reserving. Business purpose not solely a tax planning; Require an adequate amount of capital; Arms length calculation of premiums Risk shifting and risk distribution; Real risks with real possibility of loss; Pay claims; Managed and regulated as an insurance company. 4

5 I am the Taxman Federal Taxation of Captives is it an insurance company for tax purposes (1941) Supreme Court opined on insurance : Historically and commonly insurance involves risk shifting and risk distribution. Captives are typically taxed as C corporations. Captive owners and IRS have historically battled over tax issues. Over the years safe harbor provisions have been established. Helvering v. Le Gierse (1941) Risk Distribution Risk Shifting Revenue Ruling Revenue Ruling Revenue Ruling Revenue Ruling Revenue Ruling Revenue Ruling Revenue Ruling Risk Shifting and Risk Distribution Risk shifting connotes the transfer of the risk to separate party. Risk distribution mandates that enough independent risks are being pooled to invoke the actuarial law of large numbers. DO NOT FORM A CAPTIVE SOLELY FOR TAX REASONS. 5

6 Risk Shifting and Risk Distribution Revenue Ruling Parent Company Shareholder #2 Adding 50% unrelated risk (3 rd Majority of Premium party) creates risk shifting Majority of Risk and risk distribution. Captive #1 Lacks sufficient risk distribution or transfer so premiums paid are NOT deductible. Risk Shifting and Risk Distribution Revenue Ruling Parent Company Shareholder Operating subsidiaries Captive Risk Shifting and Risk Distribution were present under the relationship between Captive and subsidiaries of Captive s Parent such that the arrangement constituted insurance for federal income tax purposes. Takeaways: Insured Subsidiaries - No loanbacks - No insured accounts for less than 5% or more than 15% 6

7 Captives Require Professionals Attorney Auditor Actuary Adjuster Agent Accountant The A Team (Kevin Doherty, is an attorney and A Team member) 7

8 Q: Kevin, is going captive like going Indian? Why go captive at all? Self insurance is cheaper, right? Popular forms of retaining risk: Self Insurance Large deductible (partial self insurance) Both involve internal loss funds set aside to pay claims: Pay for current claims not necessarily the ultimate loss Not tax deductible until claim is paid. Remain on the firm s balance sheet as an asset. An insurance (captive) company has benefit of: Ability to reserve monies to pay claims in future. The policy premium paid is tax deductible (policyholder)* *Although the information contained here is presented in good faith and believed to be correct, it is General in nature and is not intended as tax advice. 8

9 Ideal Captive Candidate PC premiums in excess of $500,000. Historical losses better than industry/peer average. Employs risk management/loss control plan. Has capital to put at risk. Multiple entities or can create/join other entities. Common Types of Captives Single Parent Captives - Single owner, for whom captive provides insurance coverage. Association or Group Captives - Formed by an association or group to provide insurance coverage for members. Risk Retention Group Liability only insurance company that is owned by its policyholders. Protected Cell Captives (PCCs) A company which separates into "protected cells in which the assets and liabilities are separated from the main assets ( core ) of the company. 18 9

10 Fast Growing Type - Cell Captives AKA: PCCs, Series LLCs, SACs, SPCs, etc.by domicile Originally started in Channel Islands/offshore/UK domiciles. Single legal entity with core or general assets Cell election can be: incorporated which has its own FEIN, or: protected which assimilates with ownership of cell company Series LLC (or cell ) master LLC wherein series or cells can be created functioning similar to incorporated cells. Comparably lower capital, cost and resources required. Can be owned by parent, association, group, agency insurer or others and be rented to 3 rd parties Extremely popular with private and SME businesses Incorporated Cells/Series Cells Cell walls higher and thicker than PC. Own Board of Directors or use existing PCC Board. Own FEIN and tax filing. Inter cell agreements permitted. Can enter into own reinsurance and vendor contracts Auditing, associated costs can be reduced/shared. 10

11 25% Profitability Cycles in the P/C Insurance Industry 20% 15% 10% 5% 0% -5% :Q1 *Profitability = P/C insurer ROEs figures are estimates based on ROAS data. Note: Data for exclude mortgage and financial guaranty insurers. Source: Insurance Information Institute; NAIC, ISO, A.M. Best. ROE Captives as Control Centers $ 50 Billion GWP $150 Billion in Assets 5,500 captives 25% 20% 15% 10% The Captive Equation Control + Capacity + Claims + Coverage = CONSISTENCY 5% 0% -5% Captives keep costs down & predictable :Q1 *Profitability = P/C insurer ROEs figures are estimates based on ROAS data. Note: Data for exclude mortgage and financial guaranty insurers. Source: Insurance Information Institute; NAIC, ISO, A.M. Best. 11

12 What s the Risk Captive Coverage Strategies Traditional General Liability Workers Comp. Automobile Professional Liability Property Medical Stop Loss Directors & Officers Retained & Asset Protection Deductible & SIRs Legal Expense Reimbursement. Loss of Key Client/Account Administrative Action Business Interruption Intellectual Property Machinery Breakdown Political Risk Patent Infringement Middle Market Clients Fastest growing business segment using captives are the Small and Medium Sized Business (SMB) Retails and Consumer Products 10% Other 7% Automotive 2% Transportation 6% Mining, Metals and Minerals 3% Manufacturing 10% Aviation and Aerospace 2% Chemicals 3% 99% Construction Technology percent & of all independent businesses employ Telecom 6% fewer than 6% 500 people. Small (up to 100 employees) and Medium sized (up to 500) Life Sciences 3% Financial Institutions 20% Businesses are increasingly using a captive to Real Estate manage risk, control insurance costs, create wealth 3% Health Care and Power use & pre tax Utilities premium dollars to fund 11% future 8% liabilities. Source: Marsh Survey Group 12

13 Congress Shows it Works* The 831(b) tax election Underwriting Profits of non-life carrier exempt from Federal Income Taxation. Taxed on Investment Income Annual Premiums Written Must Be $1,200,000** or Less Applies to all Companies Within Consolidated Group A2: Introduction to 831(b) Captives This beginner-level session will provide an overview of small captive insurance companies, better known as 831(b) captives, which have become the fastest growing segment within the captive insurance marketplace. Case study examples will be included along with a discussion of pooling arrangements. DATE/TIME: Tuesday, October 22, 2013, 3:15 pm - 4:30 pm *1986 Tax Reform Act ** National Association of Mutual Insurance Carriers is lobbying for an inflation adjusted increase of the threshold to over $2 million Traditional Market Solutions No or little leverage or control- one versus carrier. Results profit carrier not necessarily policyholder. Expense ratio not controlled by policyholder perspective. Mostly non-negotiable vendor agreements/services. Nature of insurance cycle makes planning and forecasting difficult in both soft and hard market phases. 13

14 Domiciles, Domiciles, Domiciles Domicile Considerations (In) Stability of regulators Capitalization and surplus requirements vary Offshore or US (gap is closing) Access to local domicile service providers Premium taxes (some or none) Captive statutes (when last updated?) Relationship of captive insurance association w/ regulators 14

15 Line of Coverage Workers Compensation Combined Ratio: F F Workers Comp underwriting results are the worst they have been in a decade. Sources: A.M. Best; Insurance Information Institute. 15

16 Fronting and Collateral Fronting Commercial insurance carrier issues policy. Captive is reinsurer. Carrier is licensed and takes credit risk. Collateral Held for several years Letter of Credit Funds Withheld Reg 114 Trust Cash what happens if the fronting carrier is downgraded or placed in rehabilitation or liquidation 16

17 Survey Participants Lines of Business 17

18 Fronting Carriers Parent Company Shareholder Captive Use Direct Fronted Captive Issues Receives policies premium, directly issues from policies, Captive other services. Operating subsidiaries Policy Issuing Carrier Front Captive 18

19 Captive Platform Parent Company Shareholder Operating subsidiaries Captive 1. Company has 12 subsidiaries it wishes to self insure a layer of risk. 2. Feasibility Study identifies that most claims are under $ 250,000. Company elects to create a captive to retain and Reinsurance manage this layer. Excess of the SIR 3. Company capitalizes Captive and begins to fund expected losses under the $250,000 layer. Losses in excess of $250,000 is reinsured. 4. If Captive has closed out all claims for that Aggregate year, any Frequency layer profits are returned to the Company GAP via dividends. Stop Loss Gap represents the absence of funded losses and the attachment point of the Stop Loss cover. This is usually collateralized in favor of the front. Funding & Reinsurance Policy Limit of $1 Million Reinsurance Excess of the SIR $750,000 xs $250,000 Attachment Point for reinsurance is $250,000 Captive is responsible for claims under $250,000 GAP Aggregate Stop Loss 19

20 Risk Retention Groups (est. 1981) A risk retention group (RRG) is a liability insurance company that is owned by its members. Under the Liability Risk Retention Act (LRRA), RRGs must be domiciled in a state. Once licensed by its state of domicile, an RRG can insure members in all states. Because the LRRA is a federal law, it preempts state regulation, making it much easier for RRGs to operate nationally. As insurance companies, RRGs retain risk (from CICA Website). Congress created in 1981 in response to hard market, (e.g. products liability). Originally included Bermuda and Cayman Islands but since 1986 only in US. Only Policyholders can be owners. Stock or mutual. Direct writing capabilities and can be rated by AM Best. Avoidance of multiple state filings and licensing. No state guaranty fund protection for claimants. No expense for fronting fees. No workers compensation, property, personal lines. Risk Retention Groups - Industry The leading journal for the risk retention marketplace since

21 RRG Domiciles The leading journal for the risk retention marketplace since RRG Growth The leading journal for the risk retention marketplace since

22 RRGs by Number and Premium The leading journal for the risk retention marketplace since Risk Retention Group & Group Captives Risk Retention Group Group Captive Policyholders are owners Owners eligible for profits Can only be domiciled in US Does not require a front Primarily a liability carrier Homogeneous risks only Created under Congress Almost anyone can be an owner Shareholders eligible for profits Domiciled (almost) anywhere Most require a front to issue policy Can (re)insure most lines Heterogeneous or not Regulated by domicile 22

23 Cost of Forming a Captive/RRG Feasibility Study/Bus. Plan $ 8, ,00+ Captive consultant $ 10, 000 and up Legal $ 5,000-8,000 Est. Totals $ 23, , This is intended for general education purposes only Individual results may vary Feasibility Study Pre-feasibility strategy session Gather loss data, premium, policy counts for prior 5 years: Multi-year financial and loss pro forma (1) Expected, (2) Adverse and (3) Years 1-3, 5 Ownership structure including tax analysis Where to domicile captive Capitalize owned captive or PC Business plan (why is the captive/rrg being formed) 46 23

24 Get a Good Captive Manager Acts as eyes and ears for regulators. Virtual employee of the captive and performs accounting, financial reporting, banking, annual reports and filings. Reinsurance and fronting support/negotiations and wording Underwriting, policy issuance, binding coverage, investment oversight and other services upon consideration 47 Captive Formation & Timeline Feasibility Study 30 to 90 days Determine type of cover, limits, funding Financial pro forma (Cash flow, Balance Sheet, Income) Capitalization strategy Domicile analysis Business plan Submitted Application 30 to 60 days Implementation 30 days Summary: As little as 90 days or as much as 1+ year 48 24

25 RRG/Captive Expenses (est) Captive/RRG Manager $ 20,000 - $50,000+/- (some based on % of premium) Audit (subject to min.) $ 12,000 - $20,000+ Actuary $ 5,000+/- Attorney (Domicile) $ 5,000 - $10,000/-+ Adjuster/TPA $ 10,000 (also as a % of GWP) Gov t Fees/Taxes $ 1,000 $10,000+/- Est. Totals $ 53, , This is intended for general education purposes only. Individual results may vary. Online Resources 25

26 Conferences, Seminars, etc Publications & Education 26

27 Thank you! Questions 27