Protecting and Transferring Wealth With Captive Insurance


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Potentially reduce business tax, personal tax, and inheritance tax using a captive insurance company. Family owned businesses can also increase asset protection and increase money passed to future generations.

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  • Good Morning! My name is Michael Wright, I was invited to discuss how using a captive insurance company (CIC) could potentially be beneficial for your business and personal financial planning. I plan to give you an overview of the structure and how, in my opinion, a captive can be a benefit to mid size companies wanting to insure currently uninsurable risks, and to potentially benefit, from favorable claims experience and the reduced taxation on those profits. A captive can be beneficial, but is a very large undertaking and thorough feasibility and due diligence analysis needs to be completed before implementation . Let’s get started. Since we are all professional, but informal, if you have a question, please stop and ask me questions, whenever you’d like. A little about myself, I’ve been in the financial services industry for over 20 yrs. and a CFP for more than 12. Through the years I have helped many business owners maximize the benefits of owning a company and taking money out for their personal wealth. It’s a lot of risk and hard work to build a successful company, but at the end of the day, you have to make sure you can get the money out in the most effective manner. One possible tool is using a CIC, which I have thoroughly researched over the past few years.
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  • (80%) of Fortune 500 companies use Captive Insurance Companies. It’s use has been growing rapidly for mid-size business. Businesses with $20-$50million in revenues. The captive insurance company is not a panacea and is definitely not meant for all businesses. Only after a thorough dues diligence process should this strategy for your business and personal situation, be implemented. That said, if we look at the primary risks to wealth, for the right situation this is an excellent approach to mitigate many of these risks. it is important to list the main risks to Wealth for business owners such as yourselves. Uninsurable Business Risks, Personal Lawsuits, Income taxes, Wealth Transfer Taxes. Are there any large risks, I have forgotten? I’ve listed Taxes as 2 of the 4….I know we have no estate taxes for 2010. Is there anyone here that believes there is a chance income or estate taxes will be reduced by the Feds anytime soon? I just wanted to make sure we have the same perspective. It’s most likely to get worse…
  • What is a captive insurance company? Read Slide for definition
  • The main benefit, of a CIC, is the ability to transfer up to $1.2million from the primary company to a closely held insurance company. This is distributed as a tax-deductable premium and received tax-free by the Captive. Most insurance companies pay claims on 50% of the premiums they receive. We would hope your claims experience is much better. If it isn’t, it’s probably important you prefunded the risk. Taxes are bad, but there is nothing worse than being blind-sided by a huge lawsuit or a large client that goes bankrupt or finds a way to not pay a big contract. A captive may be able to help mitigate these risks. In a perfect scenario (we know life is perfect-right?) in theory, your premiums build, less operation costs and claims, and when you are ready to sell out you/or your heirs can typically sell out at cap gains rates.
  • As with every good ideal, it can misused and mis-sold. The biggest issue with the IRS has been some of the smallest CIC’s have been misused by planners and insurance people to sell large “tax-deductible” life premiums or a sham to “loan back” to the parent corporation. According to a white paper, by PacLife, there is no specific issue with funding life insurance inside a CIC, but it needs to be a moderate % of overall premium and there must be a legitimate reason for it’s use. Like most planning strategies, there needs to be a legitimate business reason (tax avoidance is not the reason) for any tax deduction. You should be able to use life insurance for key man and estate planning inside the CIC, without a problem, but we need to have your tax advisor involved to make sure it is designed properly. In the 80’s and 90’s some wealthy individuals were using international captives for income tax planning. Some were doing it right, some were using them as illegal tax shelters. Today, many states including VT, SC, NV, KY will allow businesses to domicile their insurance companies domestically, without the international hassle. There may be reasons for intl domiciled captives, but for most people wanting to insure against risks that standard insurance coverages do not cover, the good domestic is good enough. Before getting into technical jargon, I thought it best to go over a hypothetical case of how using a captive was beneficial to a business wanting to insure uninsured risks and pass any good underwriting rewards to their family, outside the estate.
  • Read From Slide
  • The captive can be owned by the Parent Corporation or it’s shares/units can be owned by other persons to assist in various planning issues. Wealth Transfer or Compensation are the most popular objectives
  • From the view point of you the insured business/business owner
  • From the view of the Captive Insurance Company
  • Assuming a favorable underwriting experience over a long period of time, the captive can be an excellent way to transfer wealth to the next generation. The “assumed” operating costs and claims experience are true guesses. During the feasibility study, the premium will be determined and a better guess to what experience you may have. Worse case scenario would be a tax deduction now for claims that happen in a short period of time. If that were to happen, you would have had a tax deduction for the expense without the costs of the insurance company.
  • Assuming a goal of wealth transfer and it makes sense to purchase life insurance inside the CIC. The wealth transferred to future generations can be relatively substantial. If 8% of the overall premium were allocated to life insurance, the net to heirs looks like this. Assumes 55, m, ns, std, aviva accumulator 3 Universal Life. $100,00 annual premium.
  • Companies most likely to benefit from a captive insurance company
  • Some of the industry groups that might be a good fit for a captive insurance company. Professional Service Firms would fit in the “mold” of medical practices and law practices.
  • The most likely risks your type of firm would want to insure probably would be contract performance (example- the economy wilts and a large vendor reneges on contract) your expenses to legally fight could be a claim and if you can not recoup the contract (bankruptcy?) your insurance company could pay your claim
  • Protecting and Transferring Wealth With Captive Insurance

    1. 1. Protecting & Transferring Wealth With A Captive Insurance Company Presented By: Michael E. Wright, CFP Wright Financial Advisors, LLC Registered Representative of and securities offered through OneAmerica Securities, Inc., Advisor.9229 Delegates Row #190, Indianapolis, IN 46240,(317)573-3838, Member FINRA, SIPC, a Registered Investment Advisor. Insurance Representative of American United Life Insurance Company, AUL and other insurance companies.  Wright Financial Advisors is not an affiliate of OneAmerica Securities or AUL and is not a Broker/Dealer or Registered Investment Advisor. Share Holder Meeting August 31, 2010
    2. 2. <ul><li>The Matter in this presentation is designed to </li></ul><ul><li>provide accurate information with regards to </li></ul><ul><li>the subject matter covered and is not </li></ul><ul><li>rendering legal, accounting, or tax advice. </li></ul><ul><li>For answers to specific questions and before </li></ul><ul><li>making any decisions, please consult a </li></ul><ul><li>qualified attorney, tax advisor or other </li></ul><ul><li>professional to address your specific needs. </li></ul>
    3. 3. Risks To Wealth <ul><li>Uninsurable Business Risks </li></ul><ul><li>Personal Lawsuits </li></ul><ul><li>Income Taxes </li></ul><ul><li>Wealth Transfer Taxes </li></ul>
    4. 4. What is a Captive? Definition: A captive insurance company is a special purpose corporation or subsidiary implemented to underwrite the risks of the parent, sponsor, or sister company. • It is recognized as an insurance company for regulatory purposes • It is recognized as an insurance company for reinsurance purposes. • Domiciled either offshore or onshore where permitted by law. • It represents the most aggressive, formalized and flexible form of self-insurance.
    5. 5. Small Captive Insurance Benefits <ul><li>Lower Insurance Costs </li></ul><ul><li>Deduct $1.2 mil premium or reserves </li></ul><ul><li>Reserves Build Income Tax-Free </li></ul><ul><li>Ordinary income to Premium </li></ul><ul><li>Prem.–Op Costs -Claims= Net Inc @C.G. Rate </li></ul><ul><li>Increased Asset Protection </li></ul><ul><li>Transfer Net Prem. Inc. to heirs=$1.2yr-cost </li></ul>
    6. 6. Captive Insurance Caveats <ul><li>Must be a legitimate business- NO Tax-Shelters </li></ul><ul><li>Long-term business </li></ul><ul><li>Beware of Excessive Life Insurance Promo’s </li></ul><ul><li>Adequate Consistent Cash Flow </li></ul><ul><li>Consider the True P&C over 831(b) </li></ul><ul><li>Specialty Tax and Insurance Pro Advice </li></ul>
    7. 7. Case Study <ul><li>Bill owns ABC Co., which has uninsured risks, that his current property and casualty insurance company will not insure. Bill creates D Co., a Captive corporation, which is an insurance company, covering ABC Co.'s uninsured risks. The stock of D Co. is owned by Bill's children. </li></ul><ul><li>Now for the fun part: suppose the insurance premium for the uninsured risks are determined by a consulting actuary to be $500,000 per year. ABC Co. pays the $500,000 premium to D Co. The entire premium is immediately deductible by ABC Co. like any other PCI. Under the Captive rules, all of the $500,000 is income-tax free to D Co. </li></ul><ul><li>ABC Co. is in a 40% tax bracket, state and federal combined. ABC Co. is only out of pocket $300,000 ($500,000 less $200,000 in tax savings). D Co. has the entire $500,000 to invest. But remember, D Co. is a Captive and must hold the $500,000, plus earnings, as a fund to pay potential claims for the risks it insures. ABC Co. pays premiums to the Captive to insure for litigation defense, professional liability and contract fulfillment . Remember with a commercial insurance company, if the insured has no losses, the CIC keeps the entire premium — no refunds. </li></ul><ul><li>Even though a Captive cannot reduce (actuarially determined) premiums, a financial windfall results (unused reserve) if the insured's actual losses are less than actuarially predicted. For example, suppose Bill's Captive (D Co.) has an unused reserve. A portion of the unused reserve can be refunded to ABC Co., reduce future premiums or be paid to the Captive's shareholders (Bill's children) as a dividend. </li></ul>
    8. 8. Reasons for Captive Formation <ul><li>Unavailability of Coverage </li></ul><ul><li>– Captive provides its owners the opportunity to fund for losses which may not be available through conventional insurance </li></ul><ul><ul><li>Litigation Defense </li></ul></ul><ul><ul><li>Professional Liability </li></ul></ul><ul><ul><li>Construction Defect </li></ul></ul><ul><ul><li>Warranty of Work Product (Short Term and Long Term) </li></ul></ul><ul><ul><li>Retained Amounts in deductibles </li></ul></ul><ul><ul><li>Coinsurance Percentage funding </li></ul></ul><ul><ul><li>Supplier Disruption </li></ul></ul><ul><ul><li>Event Disruption </li></ul></ul><ul><ul><li>Contract Completion </li></ul></ul><ul><li>• Conventional insurance industry is not meeting the needs of their clients </li></ul><ul><li>• May Provide a Tax Favored Funding Mechanism </li></ul><ul><li>• Captive offers an overall financial facility to smooth variability in earnings as a result of contingent events Ability to provide insurance coverage through policy wording that may be not be commercially available due to restrictions imposed by regulatory authorities </li></ul><ul><li>– Ability to produce an insurance policy with your own wording and to cover risks which the conventional market finds unacceptable </li></ul>
    9. 9. Reasons for Captive Formation <ul><li>Financial Planning Tool </li></ul><ul><ul><li>– Captive owned by: </li></ul></ul><ul><ul><ul><li>Family members </li></ul></ul></ul><ul><ul><ul><li>Key executives </li></ul></ul></ul><ul><ul><ul><li>Golden Handcuffs </li></ul></ul></ul><ul><ul><ul><li>Deferred Compensation </li></ul></ul></ul>
    10. 10. Accounting for Insurance <ul><li>• Insured View </li></ul><ul><li>– Risk is transferred from the insured by the payment of </li></ul><ul><li>premium </li></ul><ul><li>– Premium is an expense when paid, even though the claim </li></ul><ul><li>may not be paid for years to come, if at all </li></ul><ul><li>– Client may accrue for retained risk in a deductible, SIR, </li></ul><ul><li>Coinsurance or uninsured situation. Accruals reduce earnings </li></ul><ul><li>but are not a tax deductible expense until there is a </li></ul><ul><li>payment for a loss. </li></ul>
    11. 11. Accounting for Insurance <ul><li>Captive treatment </li></ul><ul><li>– The captive uses insurance company accounting rules as long as: </li></ul><ul><li>The captive qualifies as an insurer </li></ul><ul><li>There is risk transfer </li></ul><ul><li>There is risk distribution </li></ul><ul><li>– Subsidiary provides advantageous accounting treatment for losses that may not be available in other solutions </li></ul>
    12. 12. “ Micro” Economics 21,000,000 21,000,000 15,500,000 10,500,000 5,400,000 1,100,000 Net To Heirs 0 0 0 0 0 0 Less: Transfer Taxes @ 50% 21,000,000 21,000,000 15,500,000 10,500,000 5,400,000 1,100,000 Captive Value 2,000,000 500,000 500,000 500,000 500,000 100,000 Less: Operating 1,000,000 0 500,000 0 500,000 Less: Claims 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Less: Premium Deduction 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Income   Captive 7,200,000 7,200,000 5,400,000 3,600,000 1,800,000 360,000 Net To Heirs   7,200,000 5,400,000 3,600,000 1,800,000 360,000 Less:Transfer Taxes @ 50% 14,400,000 14,400,000 10,800,000 7,200,000 3,600,000 720000 Retained Value   480,000 480,000 480,000 480,000 480,000 Less: Income Tax @ 40% 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Taxable Income   0 0 0 0 0 Less:Premium Deduction 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Income Totals 20 15 10 5 1 No Captive
    13. 13. “ Macro” Economics Supersized Wealth Transfer       *100,000 funding for 10 yrs, Aviva Accumulator 3 UL, 55, M, NS, Std Underwriting         26,986,000 26,986,000 21,486,000 16,486,000 11,386,000 7,086,000 Net To Heirs 5,986,000 5,986,000 5,986,000 5,986,000 5,986,000 5,986,000 Life Insurance Proceeds At Death*     0 0 0 0 0 0 Less: Transfer Taxes @ 50% 21,000,000 21,000,000 15,500,000 10,500,000 5,400,000 1,100,000 Captive Value 2,000,000 500,000 500,000 500,000 500,000 100,000 Less: Operating 1,000,000 0 500,000 0 500,000 Less: Claims   0 0 0 0 0 Less:Income Tax @ 40%   0 0 0 0 0 Taxable Income 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Less: Premium Deduction 24,000,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Income     Totals 20 15 10 5 1 Captive- SuperSized Transfer Plan    
    14. 14. Most Likely to Benefit <ul><li>• Privately Held Company </li></ul><ul><li>• $25 Million in revenues </li></ul><ul><li>• $500,000 in existing P&C Premium </li></ul><ul><li>• At least $1.5 million in Net Income Before </li></ul><ul><li>Taxes </li></ul><ul><li>• Uninsured Risks/Self-insured Risks </li></ul>
    15. 15. “ Good Fit” Industries <ul><li>• Agricultural Groups </li></ul><ul><li>• Restaurants and Hotels </li></ul><ul><li>• Professional Service Firms </li></ul><ul><li>• Manufacturers </li></ul><ul><li>• Subcontractors </li></ul><ul><li>• General Contractors </li></ul><ul><li>• Automobile Dealers </li></ul><ul><li>• Transportation and related businesses </li></ul><ul><li>• Wholesale Distributors </li></ul>
    16. 16. Common Risks to Insure <ul><li>• Policy Exclusions </li></ul><ul><li>• Deductible Amounts </li></ul><ul><li>• Construction Defects </li></ul><ul><li>• Product Liability </li></ul><ul><li>• Product Recall </li></ul><ul><li>• Product Warranty </li></ul><ul><li>• Employment Practices </li></ul><ul><li>• Wrongful Acts </li></ul><ul><li>• Reputational/brand/loss of income risks </li></ul><ul><li>• Litigation defense </li></ul><ul><li>• Contract Completion </li></ul>
    17. 17. Our Services <ul><li>• Key areas of Consulting: </li></ul><ul><li>Estate And Wealth Transfer Planning </li></ul><ul><li>Life Insurance Design and Implementation </li></ul><ul><li>Assist in Selection and Coordination of Third Party Manager who provides: </li></ul><ul><li>– Feasibility Analysis, Program Initiation, Education, and Goal Setting </li></ul><ul><li>– Captive Conceptual Design Development </li></ul><ul><li>– Pro Forma Modeling </li></ul><ul><li>– Domicile Analysis; </li></ul><ul><li>Business Plan and Models </li></ul><ul><li>– Vendor Analysis; </li></ul><ul><li>– RFP preparation </li></ul><ul><li>– Tax and Legal Opinion Coordination Implementation and Follow Through </li></ul>Registered Representative of and securities offered through OneAmerica Securities, Inc., Member FINRA, SIPC, a Registered Investment Advisor. Insurance Representative of American United Life Insurance Company, AUL and other insurance companies.  Wright Financial Advisors is not an affiliate of OneAmerica Securities or AUL and is not a Broker/Dealer or Registered Investment Advisor.