Todd bailey captive fundamentals (rev051418)

For Educational Purposes Only. ©2018 Fortress Risk Management, LLC. All Rights ReservedFor Educational Purposes Only. ©2018 Fortress Risk Management, LLC. All Rights Reserved.
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CAPTIVE
INSURANCE
Turning risk into wealth.™
Todd Bailey JD MAcc
www.FortressRisk.com

For Educational Purposes Only. ©2018 Fortress Risk Management, LLC. All Rights Reserved
OUR MANAGEMENT TEAM
Todd Bailey,
JD MAcc
Founder & CEO
Paul Mason, JD
Founder & President
Josh Lunn COO
Chief Operating
Officer

CAPTIVE INSURANCE PROCESS
3
Fundamentals
Feasibility
Formation
Function
Affiliate with Fortress

FUNDAMENTALS: BUSINESS RISKS
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Premises
Policy
Exclusions
Litigation
Key
Customer
Supply
Chain
Data
Breach
Auto
Accident
Theft
Fire
Flood

MANAGE RISK:
(1) Fund a Reserve, or
(2) Captive Insurance
MANAGE RISK:
Commercial policy
MANAGING THE RISKS
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Premises
Policy
Exclusions
Litigation
Key
Customer
Supply
Chain
Data
Breach
Auto
Accident
Theft
Fire
Flood

MANUFACTURING CASE “WIDGET
CORP”
• Manufactures and sells “widgets”
• Annual sales: $6 million+
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OWNERS
• Primary Concern: “Challenging Risks” that cannot be covered
by a commercial insurance policy.
• Secondary Concern: Taxes

WIDGET CORP RISKS
RISK
TYPE
COMMERCIAL
POLICY
CAPTIVE
INSURER
Fire
Flood
Cyber Risk Limited
or Excluded
Supply-chain Risk
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




CAPTIVE INSURANCE
FUNDAMENTALS
8
Supplemental (keep standard policies)
Business Casualty Risks
Pooled in fronting carrier
Reinsured in reinsurance companies

SAMPLE OF ADDITIONAL RISKS
ACTUARY CONSIDERS
• Brand Protection
• Business Interruption
• Construction defects
• Crop
• Cyber risk / Data breach
• Deductibles
• Employment practices
• Exclusions in Policy
• Food-borne Contaminants
• Independent Contractor &
Chargebacks
• Key Person
• Key Customer
• Key Supplier
• Litigation
• Mold, Pollution
• Products liability
• Professional Liability
• Regulatory Risk
• Reputation
• Supply Chain Interruption
• Warranties
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IRC § 831(B) TAX INCENTIVE
• Tax Break--
• Tax only in investment income
• No tax on insurance profits (premiums – claims = profits)
WHY THE TAX BREAK?
TO HELP BUILD RESERVES
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IRC § 831(b) Key Dates:
1986 [enacted], 2015 [improved] & 2018 [tweaked]

CAPTIVE INSURANCE IS INSURANCE
• Risks not covered include
• Bad A/R (unless a lender)
• Earthquakes in California
• Flood insurance in 9th Ward of New Orleans
• Terrorism
• Undocumented workers—fear of Gov’t raid
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WHY HAVEN’T I HEARD OF IT?
•Not a fit for all companies
•Businesses only
•No Challenging Risks
•Minimum size
12

STEALTH? NO
•SS-4 (EIN)—Form 1120PC will be filed
•IRC 831 Election—Must File with first tax return
•Annual tax return Disclosure
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NOTICE 2016-66: INFO TO IRS
(11-1-16)
•What? Report to IRS about
•Risks
•Underwriting
•Premiums
•Claims process
•Dividends and loans
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NOTICE 2016-66 – INFO TO IRS
•Why? Avrahami Case(US Tax Court Aug 21, 2017)
•Insufficient risk distribution (pool of 5)
•Flawed actuarial analysis
•Terrorism risk that would never be
paid
•Details: No documentation of $200k
“loan”
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BUILDING A CAPTIVE
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Multiple Insured Companies
Challenging risks
Pooling—Risks & Premiums
License + Fees + Professional Work

BUILD AROUND EXISTING
INSURANCE COMPANY
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Insurance
License
Under-
writing
Claims
Admin.
Risk Pools
Regulatory
Filings
Annual
Audits
ALREADY
INVOLVED:
• Actuaries
• Attorneys
• Underwriters
• Accountants
• Insurance
Manager
• Licensing Fee
• Capital
Contribution
• Annual Audit
• Pooling Expenses
• Financial
Statements
Insurance
Company
Risk Pools

MANAGING UNEARNED PREMIUMS
•Manage risks & pay claims
•Maintain liquidity to pay claims
•Stocks, bonds, funds, bank deposits, etc.
•No
•Life insurance
•Illiquid investments
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MANAGING EARNED PREMIUMS
i.e. RETAINED EARNINGS
•Build additional reserves
•Qualified dividends (LTCG)
•Loans
of retained earnings to shareholders @ AFR
(performing loans bearing interest per IRS
guidelines; possibly collateralized)
•Liquidation (LTCG)
19

CAPTIVE INSURANCE PROCESS
20
Fundamentals
Feasibility
Formation
Function
Affiliate with Fortress

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THE PROCESS: FUNDAMENTALS
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•Fortress Business Intake Form
• Company Info
• Risk History
• Copies of Documents (Tax Returns, etc.)
•Call or Webinar with Client:
• Client
• Client’s Advisors
• Fortress Risk
www.FortressRisk.c
om

22
THE PROCESS: FEASIBILITY
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•Actuary’s Role
•Actuary Questionnaire
•Actuary’s Report
•Examples of Info for Actuary:
• Copies of Policies
• Loss history
• Questions about various risks

23
THE PROCESS: FORMATION
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•Formation & Procedures Form
•Corporate Roles
•Submit to jurisdiction
•Formation of reinsurance company
•Insurance license

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THE PROCESS: FUNCTION
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•Policy
•Premium Payment
•Claims
•Annual Maintenance
•Tax Return
•Insurance License
•Financial Statements
•Minutes, etc.

LEGAL PRECEDENTS
• Internal Revenue Code section 831 (TRA 1986)
• Humana, Inc. vs. Comm’r, 881 F.2D 247 (6th Cir 1989)
• Gulf Oil Corp. v. Comm’r 914 F.2d 396, 66 A.F.T.R.2d 90-5552, 90-2 USTC P 50,496 (3rd Cir. 1990)
• Harper Group vs. Comm’r (1992) 96 T.C. 45 (1991), aff’d, 979 F.2d 1341 (9th Cir. 1992)
• Amerco, Inc. v. Comm’r 979 F.2d 162 (9th Cir. 1992)
• Sears, Roebuck & Co. v. Comm’r, 972 F.2d 858 (7th Cir. 1992)
• Ocean Drilling & Exploration Co. v. Comm’r, 988 F.2d 1135 (Fed.Cir. 1993)
• Malone & Hyde vs. Comm’r, 62 F.3d 835 (6th Cir. 1995)
• Hosp. Corp. of Am. v. Comm’r, T.C. Memo. 1997-482, 1997 WL 663283
• Kidde, Ind. vs. Comm’r, 40 Fed.Cl. 42 (Fed.Cl. 1997)
• United Parcel Service of America, Inc. v. Comm’r, 254 F.3d 1014 (11th Cir. 06/20/2001)
• Rev. Rul. 2001-31 (2001)
• Notice 2005-49 (2005)
• Rev. Rul. 2008-8 (2008)
• Securitas Holdings, Inc. v. Comm’r, T.C. Memo. 2014-225
• Rent-a-Center v. Comm’r, 142 T.C. No. 1 (2014)
• PATH Act 2015 (Protecting Americans from Tax Hikes—Omnibus Bill Dec. 2015)
• IRS Notice 2016-66 (Nov 2016)
• Avrahami v. Comm’r, 149 T.C. 7 (Aug. 21, 2017)
• Consolidated Appropriations Act of 2018 (Mar 2018)
• Reserve Mechanical v. Comm’r, T.C. Memo. 2018-86 (June 18,2018)
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* Tax Calculation Disclaimer
 Tax calculations are for discussion and educational purposes only.
 The 0.9% Medicare surcharge for high earners was ignored. Thresholds are $250,000 for married filing
jointly; $125,000 for married filing separately; $200,000 single; $200,000 head of household.
 Phase outs of exemptions and deductions are ignored for the sake of simplicity.
 The calculations assume that earnings are above the Social Security base.
 Calculations use top marginal corporate and individual rates.
 Tax laws and rates are subject to change. These slides may not reflect the latest income tax rates and
changes to the Internal Revenue Code.
 Calculations are for discussion only and should not be relied upon. Consult your tax and accounting
professionals for your own tax calculations. These are generalized calculations for discussion purposes.
 The sole purpose of the tax calculations is a marginal analysis which examines relative changes in taxation.
 IRC 199A issues may significantly impact the tax examples in this educational material.
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Important Disclosures and Limitations
 For informational and educational purposes only.
 Fortress Risk Management, LLC (“FRM”) and its principals and employees do not provide legal,
accounting, actuarial, underwriting or investment services.
 FRM does not determine the amount of premiums. Risks are analyzed and premiums are determined by
an independent actuary.
 FRM is not an investment advisor and does not give any advice or recommendations as to securities or
investments nor any evaluation of any investment portfolios you may have.
 Any implementation of FRM recommendations should be made only after consulting with your legal,
tax, accounting and risk management professionals.
 IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice
provided in this communication is not intended or written to be used, and it cannot be used by the
recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the
recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a
partnership or other entity, investment plan, arrangement or other transaction addressed herein.
 The Middle Market Risk Management Solution™ is a registered mark of Fortress Risk Management LLC, a
Wyoming limited liability company.
 These materials are copyright protected by Fortress Risk Management, LLC 2014-2017. All Rights
Reserved. No part of this material or any of its contents may be reproduced, copied, modified or
adapted, without the prior express written consent of FRM.
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