1. Captive insurance is becoming more viable for middle-market companies as a way to customize coverage to their needs and gain more control over claims payments compared to traditional commercial insurers.
2. Choosing the right domicile is important, as not all jurisdictions are the same. For a captive to be economically feasible, it needs to operate in a jurisdiction with an efficient and accessible regulatory environment.
3. Proper tax structuring and management of the captive insurer is critical to achieve tax benefits under the Internal Revenue Code and avoid penalties. With the right advisors, captives can provide benefits to middle-market companies while complying with tax laws.
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Servicing the
middle market page 29
2. Servicing the
middle market
Stewart A Feldman, of Capstone Associated Services, on the growth
in captive uptake among smaller, middle-market companies
F
or years the largest US compa -
nies have realised the benefits of
alternative risk financing/captive
planning. Principal among the
reasons is the ability to customise cover -
ages to the insureds’ needs rather than
simply relying on standard conventional
policies riddled with restrictive exclu -
sions. Also, captives are often more cost-
raditional carriers,
which pay out only a very small part of
their claims in actual losses, reserving
much of the actual premiums for market -
ing costs, executive compensation, com -
missions, investment losses, litigation
with insureds and other uses of proceeds
unrelated to the interests of the insureds.
More recently, other good reasons for
captive planning have developed. Many plant or supplement current prop - businesses have to sue their insurance
of the largest conventional insurance erty and catastrophe coverages. For the companies to recover unpaid claims or
companies ar result of business owner, a captive provides the face declaratory judgement actions. The
poor investment decisions. Because of insureds with greater influence over the certainty of payment from a captive is,
huge losses in these insurers’ core busi - financial health and well-being of the in - for many, a better alternative.
nesses, their stock values have declined surer, rather than being at risk of having Commercial insurers often tend to rely
significantly and, in some cases, insurers coverages negated due to poor on policy exclusions, which create un -
are now dependent on the US govern - investment decisions by conventional certainty among the insureds regarding
ment for their survival. The disasters that insurers or the traditional propensity to what is actually a ‘covered risk’. In con -
have befallen Hartford, AIG and others deny commercial claims. trast, policies issued by captive insurers
have made many insureds question the can be custom-designed to supplement
advisability of conventional carriers. The Funding claims ‘holes’ in existing commercial policies,
situation has become sufficiently extreme Some conventional insurers have long or to pr overage
that some insurers have petitioned the enjoyed a reputation for not paying not o red or unacceptably priced by
US government to become bank holding claims. Yet businesses depend on these conventional insurers. In some cases, the
companies in order to further secure same companies for coverage when they captive’s policies specifically take over
emergency government aid. are sued. Middle-market companies are when the conventional carrier denies
As a result of the growing uncertainty, looking for more certainty from their coverage on the underlying policy.
more middle-market companies are insurance company when filing a bona
looking to captives as a viable risk-plan - fide claim. It is almost commonplace for Controlling claims payments
ning alternative. Long the bastion of the some conventional insurers to deny even Captive insurance claims payments mean
largest publicly held companies, captives bona fide claims as part of the ‘nego - no more red tape and no more cover -
have become viable for the substantial, tiation process’, especially when facing age litigation when it comes to claims
closely held business that seeks to sup - a large commercial loss. As a result, handling. Due to the special relationship
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3. “
between the captive insurer and its in - for small captives), a client needs to be
sureds, claims handling is no longer the
adversarial relationship that many busi -
prepared to move to a new jurisdiction.
By way of example, in recent years there Not all
domiciles are
nesses have come to expect from their has been an exodus of captives out of the
conventional liability carrier. Claims British Virgin Islands as its environment
investigations, verifications, adjustments has changed, with those captives moving
and payments can all be done expedi -
tiously and efficiently through a captive.
about equally between other onshore and
o re jurisdictions. the same. For a
Choosing the right domicile
Choosing the right domicile is critical
What about the Obama administra-
tion’s proposals for offshore entities?
captive to be
and will certainly have ramifications
over the captive’s life. Domiciles are
Prevalent in the news recently has been
the Obama administration’s promise of
economically
not fungible and must be matched with
the intended operations of the captive
greater scrutiny of the taxatio
shore entities. However, these proposals
-
feasible, it must
operate in a
insurer. have little application to alternative risk
For example, some domiciles specialise planning, at least for the middle market.
in larger captives for publicly held com - Alternative risk planning for the mid -
panies or involving hundreds of millions
in annual premium. Regulating a small
dle market can be done either domesti -
cally o ore. The choice of domi - jurisdiction with
an efficient
captive requires far rent expertise cile (choice of regulator) is unrelated
than regulating a captive formed by a to federal income tax issues because,
conventional insurer, such as Berkshire as properly implemented under the
Hathaway, which would typically be
domiciled in Bermuda or Ireland. A
Internal Revenue Code, there is no tax
rence between onshore an re
and accessible
jurisdiction like Bermuda may be well
positioned to regulate captives for large
captives, at least for the middle market.
More specifically, a captive owner has regulatory
environment”
public companies, like Exxon, which has the ability to tak re taxation
al le the ever-changing the table by domesticating the non-US
regulatory requirements. However, Ber - domiciled captive in the US so that it is
muda is not a jurisdiction appropriate always a domestic US company for tax
for the captive insurer of, for example, a purposes. Under a special provision of
regional general contractor. The nature the US Internal Revenue Code, a foreign yet unidentified, losses. In contrast, a
of Bermuda’s regulation, required insurer with Internal Revenue Service ap - business entity, other than an insurer, can
reporting and legislative and regula - proval may become a ‘US insurer’. In this only deduct losses once they occurred.
tory mandates negates this otherwise regard, qualified and highly experienced Proper tax structuring and manage -
recognised insurance domicile as being US tax advice is a must. ment of the insurer in order to satisfy
practical for the small and intermediate When properly structured, whether the the many requirements of the Internal
captive markets. captive is formed in the US (for example, Revenue Code is critical to the ongoing
Not all domiciles – whether onshore Vermont) or abroad (for example, Ber - success of the insurance arrangement if a
re – are the same. For a cap - muda or Anguilla), the captive is always a current tax deduction is to be achieved.
tive to be economically feasible, it must US company for tax purposes. Capstone- Combined with the management of the
operate in a jurisdiction with an efficient administered captives file US tax returns insured risks and the investment of the
and accessible regulatory environment. and have taxpayer Employer Identifica - insurer’s assets, these are among the key
In recommending a jurisdiction and its tion Numbers (EINs). They are taxed lynchpins to the insurer’s success.
regulatory regime, the key criteria are under special and longstanding US tax Captive insurance enables small busi -
that the domicile is responsive, efficient, provisions that encourage the formation ness owners to better manage insurance
well respected and capable of providing of property and casualty insurers provid - needs, including cost, coverage, service
regulated ing coverage to US businesses. Long - and capacity. In 2009, the middle market
entities. A jurisdiction skilled in handling standing provisions under the Internal will continue to be a valuable source of
larger companies, which have a legal Revenue Code provide for either full or captive formations. The option remains
le to deal with changing regulato - partial federal income tax exempt status. an attractive one as companies focus on
ry requirements, may not be appropriate However, not complying with this highly the overriding need to reduce costs and
for the smaller middle-market company. technical legal area leads to significant y.
For this reason, demonstrated expertise penalties. It is for this reason that our af -
in the regulation of captives for middle- filiated law firm remains highly involved Stewart A Feldman
market companies is critical. In contrast, in the administration of alternative risk serves as manag-
some jurisdictions, especially those in the planning. ing partner of The
US, view captive regulation as a means Feldman Law Firm
and as general
of creating tourism dollars, employment Proper tax structuring and counsel to Cap-
for local professionals or new streams of management of the insurer is critical stone Associated
income to tax. It is well recognised that captive insurers, Services, which
Finally, as with life generally, things at least in terms of ‘for profit’ compa - designs, forms and
administers prop-
change. When a domicile decides, for nies, are in large part a creation of the erty and casualty
example, to focus on attracting larger Internal Revenue Code. This is because insurance compa-
insurers (and in doing so make the the Code only allows an ‘insurance nies for the benefit
regulatory environment unattractive company’ to currently deduct future, as of third parties.
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