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An Introduction to Captive Insurance

An Introduction to Captive Insurance. F. Hale Stewart, JD, LLM, CTEP, CWM, CAM Author of the book U.S. Captive Insurance Law Captiveinsuranceinfo.com 832-330-4101. Who Should Form A Captive?. A company that has an above-average risk profile.

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An Introduction to Captive Insurance

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  1. An Introduction to Captive Insurance F. Hale Stewart, JD, LLM, CTEP, CWM, CAM Author of the book U.S. Captive Insurance Law Captiveinsuranceinfo.com 832-330-4101

  2. Who Should Form A Captive? • A company that has an above-average risk profile. • A company or individual with the financial resources to contribute to the captive. • Finally, a company should have a good combination of income and risk • Ideally, a company should have $3 million in gross revenue • But a company that has $1-$3 million may have enough risk to warrant looking at a captive. • Please call if you have questions

  3. What Companies Are More Likely to Benefit From a Captive • Doctors and other professionals • Manufacturers • Commercial real estate • Construction companies • Transportation companies • Shipping Companies

  4. What Are the Benefits of Forming A Captive? • Custom Insurance Policies • The Beech Case • Using Individual loss experience in determining insurance rates • Broader Insurance Coverage • Third party insurer insures standard risk • The captive underwrites specialty risk • Asset protection • Estate Planning • Tax arbitrage

  5. What Are the Steps to Forming a Captive? • After a company decides to form a captive, the next step is to perform a feasibility study, which has three objectives. • It provides a blueprint for the entire captive program. • Second, it aids in compliance. • Third, the study can aid in selling important decision-makers within the organization on the plan.

  6. What Are the Steps to Forming a Captive? • The jurisdiction where the captive is being formed must determine if forming the captive is in the jurisdiction’s best interest. To do that, they will consider • (i) The character, reputation, financial standing and purposes of the incorporators; • (ii) The character, reputation, financial responsibility, insurance experience and business qualifications of the officers and directors; and • (iii) Such other aspects as the commissioner shall deem advisable.

  7. What Are the Steps in Forming a Captive, con’t • Next, the applicant must make a formal application to open an insurance company. The application must typically contain the following information • (A) The amount and description of its assets relative to the risks to be assumed; • (B) The adequacy of the expertise, experience, and character of the person or persons who will manage it; • (C) The overall soundness of its plan of operation; • (D) The adequacy of the loss-prevention programs of its parent, member organizations, or industrial insureds, as applicable; and • (E) Other factors considered relevant by the commissioner in ascertaining whether the proposed captive insurance company will be able to meet its policy obligations • Finally, there is the issue of original capital and surplus.

  8. Running the Captive • Domicile manager • Legal counsel • Audit • Actuarial Services • Investment manager

  9. Shutting Down the Captive • In most states, one of the following seven reasons will allow a state regulator to shut down a captive: • 1. Insolvency or impairment of capital and surplus. • 2. Refusal or failure to submit an annual report … or any other report or statement required by law or by lawful order of the director. • 3. Failure to comply with the provisions of its own articles of incorporation, bylaws or other organizational document. • 4. Failure to submit to an examination or any legal obligation related to the examination. • 5. Refusal or failure to pay the cost of an examination. • 6. Use of methods that, although not otherwise specifically prohibited by law, render its operation hazardous or its condition unsound with respect to the public or to its policyholders. • 7. Failure otherwise to comply with the captive statute.

  10. The IRS Fought Captive Insurance For Nearly 30 Years • They used three arguments • The Economic Family • Nexus of Contracts • Assignment of Income • No Court Accepted Any of the IRS’ arguments

  11. Safe Harbor Guidance, Part I • Under Harper, a captive must comply with a three prong test: • (1) whether the arrangement involves the existence of “insurance risk”; • (2) whether there was both risk shifting and risk distribution; and • (3) whether the arrangement was for “insurance” in its commonly accepted sense. • The duck test – does the company “walk and talk” like an insurance company?

  12. Safe Harbor Guidance, Part II • The IRS has issued several Revenue Rulings that provide further safe harbor guidance • A captive must derive at least 50% of its insurance revenue from a non-parent. • Or, a captive must have at least 12 subsidiaries in order to have sufficient risk distribution.

  13. Private Letter Rulings, or, the Ultimate Safe Harbor • A Private Letter Ruling (or PLR) is "issued for a fee upon a taxpayer's request and describes how the IRS will treat a proposed transaction for tax purposes."  • Private Letter Rulings create certainty – we know how the IRS will view a specific transaction

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