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Please join us next month as we discuss the modern trends surrounding captive insurance. Wealth managers who have an interest in captives will likely find the information and presentation useful. CLICK HERE TO REGISTER

For additional information on captives see, Advisorfyi.com–States Competing for Captives Insurance Business, Alternative Risk Transfer Revisited, Captive Market Continues to Grow, LLC Series and Cell Companies, Group Captive Insurance Companies and Year End Tax Considerations, and A Dollar Saved…Captive Insurance Company Costs

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Why is this Topic Important to Financial Professionals? This blogticle presents discussion on one area of the insurance world that is a hot topic. More and more businesses are seeking alternative risk insurance structures to cover a variety of risks. Those wealth managers who can assist clients in alternative risk transfer decision making provide additional resources and services over and above other competition.

What is Alternative Risk Transfer, or ART?

Alternative risk transfer, or ART is defined by International Association of Insurance Supervisors, to mean, “[a]ny form of risk transfer that include at least an element of insurance risk, opposed to pure financial risk, other than a pure insurance contract.” [1]

Alternative risk transfer has a long history. “The oldest known trace” of such insurance can be found in a maritime policy issued in Genoa in 1370. “That policy covered the shipment of goods from Genoa to Sluys and the most dangerous portion of the shipment trip, from Cadiz to Sluys, was reinsured.” [2]

Some distinguishing characteristics, as compared to traditional insurance or pure insurance contract, may include but are not limited to:[3]

• Non-traditional risk funding;
• Underwriting income retention;
• Unique and individual underwriting, i.e., lines of coverage can varry depending on types of risk a may be exposed to;
• Access to coverage for risks the conventional insurance market may consider uninsurable or too costly to insure through traditional methods; or
• Potential to reinsure certain risks

Why would a business consider ART?

Generally, there are uninsurable risks or risks that are prohibitively expensive or otherwise unavailable to insure through the traditional insurance market that a business may be exposed to by operating in its environment. These risks pose various threats to the operation of the business, and just as traditional risks such as fire, theft and flood loss are covered though risk diversification, a business may want to consider the possibility of other detrimental events that could significantly negatively impact its business, and take affirmative action to limit the possibility of losses.

The alternative risk transfer market can be divided into two general categories: “(1) alternative carriers and (2) alternative products.” [4] Examples of the former include:

• Self-insurance arrangements
• Captive insurance companies, which could include, wholly owned insurance subsidiaries, group captive insurance arrangements or some combination or multiple structures.
• Risk retention groups, which are generally formed to, as the name states, retain risk within a group of similar businesses or similar risks.

The latter general category may include[5]:

• multiline products
• specialty products written through an insurer such as Lloyds of London
• some derivatives and finite risk products

Generally, the “[i]nsurance industry has realized that though conventional risk transfer solutions are almost always [favored] (when available at viable pricing levels), it becomes essential to investigate the value of non-conventional solutions and to focus on the benefits that can be derived from these solutions.” [6]

In sum, there are situations where alternative risk transfer may be preferable to more traditional alternatives. Wealth managers that can identify potential cost savings for clients through alternative risk transfer present a competitive advantage.

Next week’s blogticle will discuss some particular risks that may be considered for ART.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] International Association of Insurance Supervisors (IAIS).  “Glossary”.   http://www.iaisweb.org/index.cfm?pageID=47##.  Last Accessed 8/24/2010.

[2] See generally Vladimir Njegomir and  Rado Maksimović. Risk Transfer Solutions for the Insurance Industry. Economic Annals, Volume LIV, No. 180, January – March 2009 citing, Herrmannsdorfer, F. (1926), Bedeutung und Technik der Rückversicherung, Verlag von Piloty & Loehle, München,p. 332.

[3] IAIS. Glossary.

[4] “Alternative Risk Transfer”.  Deepak Godbole.  General Insurance Corporation of India Bimaquest – Vol. IV Issue I1, 37, 41 July 2004. http://www.niapune.com/pdfs/Bimaquest/Volume-4_Issue%202/godbole.pdf.  Last accessed 8/24/2010.

[5] Id.

[6] Id. at 39.

Why is this Topic Important to Wealth Managers? This blogticle discusses captive insurance companies and how the number of captives worldwide continues to grow. Also discusses the proposed Federal Regulations which would greatly expand flexibility in the captive market. Now is a good time to explore captive options for those wealth managers who are working with clients who may not have yet considered how to more efficiently self-insure risk.

Business Insurance‘s 2011 captive insurance report estimates the ongoing operation of over 5,617 captive insurance companies worldwide by the end of 2010. In addition, new captive domiciles include, Denmark, Finland, Norway and Sweden. [1]

Vermont leads the U.S. captive market with over 570 captives and Utah places second on the list with over 188 captives.

The number of captive insurance companies is growing. The growth can partly be attributed to the captive cell company laws that are enacted in many foreign jurisdictions.

In fact in 2010, the Internal Revenue Service (IRS), Department of the Treasury of the United States issued a notice of proposed rulemaking regarding, in part, the classification for U.S. Federal tax purposes of a foreign series or cell that conducts an insurance business. [2] The proposed regulations provide that, whether or not a foreign series or cell that conducts an insurance business is a juridical person for local law purposes, for U.S. Federal tax purposes it is treated as an entity formed under local law. The proposed regulations would affect foreign series or cells that conduct insurance businesses and their owners.

By issuing the prosed guidance in 2010 the United States Treasury attempts to remedy the situation that under current U.S.  law that there is little specific statutory guidance regarding whether for U.S. Federal tax purposes a captive cell is treated as an entity separate from other cells or the cell company, as the case may be, or whether the company and all of its series (or cells) should be treated as a single entity.

The rule provided in the proposed regulations is designed to provide greater certainty to both U.S. taxpayers and the IRS regarding the tax status foreign captive cells that conduct insurance businesses. In effect, taxpayers that establish cells are placed in the same position as persons that file necessary documentation for a separate legal entity. The IRS and the Treasury Department believe that a rule generally treating foreign insurance cells as separate legal entities would be consistent with taxpayers’ current ability to create similar structures using multiple legal entities that can elect their Federal tax classification pursuant to Federal Regulations.

The cell captive insurance models provide for some of the very same benefits as ownership of a traditional captive insurance company, which include, but may not be limited to:

• Individualized underwriting and premium allocations
• retained underwriting profits depending on claims experience
• access to insurance products currently unavailable or too costly to insure

These models can also offer a lower price point for businesses who may be considering using alternative risk transfer products for the first time.

Some considerations wealth managers should account for include, but are not limited to:

• upfront and annual cost to insureds
• jurisdiction and regulatory oversight of the cell captive insurance company

For further discussion on captive cells see: AdvisorFY:I LLC Series and Cell Companies.

Tomorrow’s blogticles will discuss topics relating to insurance and financial planning.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Business Insurance. Business Insurance ranks captive domiciles worldwide. http://www.businessinsurance.com/article/20110314/NEWS/110319954. Posted March 14, 2011. Last Accessed March 16, 2011.

[2] See 75 Federal Register55699-01. “Series LLCs and Cell Companies”. Tuesday, September 14, 2010.

Why is this Topic Important to Wealth Managers? Serves as a reminder to wealth managers who may already have, or are currently, considering any alternative risk transfer products for their clients.  Discusses basics applied to captive insurance companies in consideration with traditional prepaid expenses. 

As we have discussed in previous blogticles, captive insurance can be a viable method to more efficiently protect against certain risks under various circumstances.  For discussion on these topics please see our blogticles on AdvisorFYI from the week of August 30^th, Monday through Wednesday, Alternative Risk Transfer Basics, Risk and Self-Insurance, and Captive Insurance Company Introduction.  

In addition, we have discussed in previous blogticles the ability to deduct prepaid expenses for certain items, both from an accrual basis and cash receipts and disbursements method taxpayer approach.  One such class of deductions that is generally allowable is, “insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property.” [1]

See generally our blogticles from November entitled, Year End Tax Planning: Pre-Paid Insurance Expense For Accrual Accounting Taxpayers, and Year End Tax Planning: Pre-Paid Expenses For Cash Accounting Taxpayers.

A discussion of the deductibility of insurance premiums paid to a captive insurance company is complex.  It is recommended that wealth managers work with knowledgeable attorneys and other experts who specialize in the field of alternative risk transfer taxation.  Nevertheless, there are a number of captive insurance options that “fit” the many rules required for the deduction of premiums as an insurance expense. 

Moreover, as the year draws closer to an end, some of those options have become infeasible due to time constraints.  Other options, however, still may be available to clients’ businesses that have insurable interests that are currently being uninsured or insured through some other less effective means. 

One such example could be the class of captives that is generally known as the group, association or rent-a-captive model.  These captive insurance models provide for some of the very same benefits as ownership of an insurance company, which include, but are not limited to: 

• individualized underwriting and premium allocations
• retained underwriting profits depending on claims experience
• access to insurance products currently unavailable or too costly to insure

These models can also offer a lower price point for businesses who may be considering using alternative risk transfer products for the first time. 

Some considerations wealth managers should account for include, but are not limited to: 

• upfront and annual cost to insureds
• jurisdiction and regulatory oversight of insurance company
• officers, directors, and management of company, products and programs

Lastly, there are a number of promoters, companies, individuals and professionals who promote captive insurance products.  It is important to realize not everyone knows what they’re talking about.  In fact, some are even outright crooks.  When consulting with individuals who are “qualified” ask lots of questions and try to verify the information shared with you.  Remember a little extra due diligence now can save you a lot in the long run.

Tomorrow’s blogticle will continue to discuss additional resources available to wealth managers.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 C.F.R. § 1.162-1; U.S. v. Weber Paper Co., 320 F.2d 199, 63-2 U.S. Tax Case. (CCH) P 9630, 12 A.F.T.R.2d 5256 (8th Cir. 1963). 

Why is this Topic Important to Wealth Managers? Provides specific information in regards to costs relating to the formation of an insurance company.  Discusses multiple domicile options and how they relate to each other.

Wealth managers may be interested to know generally what costs are involved to form and manage a captive insurance company in different jurisdictions.  Take for example Vermont.  It is known as the “Captive Capital” here in the States, and for good reason, Vermont has licensed over 900 captives at last count. [1]

The licensing fees in Vermont total $4,800 (in the first year and only $300 a year thereafter.) [2] However, there are a couple of downsides to the preliminarily greener pastures.  First, Vermont requires initial capitalization of a “pure”, which includes a traditional single parent, captive of $250,000. [3] Secondly, Vermont requires the captive to pay minimum premium tax of $7,500 which has an underwriting level of approximately around $2 million dollars at a rate of 0.38%. [4]

As a general rule, the formation and annual expenses, including premium taxes, of captive insurance companies will be lower in most offshore jurisdictions rather than domestic domiciles.  [5]

One offshore jurisdiction known for international finance is considered an industry leader in captive insurance; “Bermuda, where almost twenty-five percent of the World’s captives are registered.” [6] Next are the Cayman Islands which have a slightly less number of captives, behind Bermuda and Vermont with approximately 760 companies.  The domicile had total insurance reserves held in captive insurance companies of US $42.3 billion as of June 31, 2010. [7] The annual fee to the insurance department for a captive insurance company, or “Class B” insurance license, as it’s know in Cayman, is currently $10,365.85.  [8] One significant benefit at present, is that a captive does not have to pay a tax on premiums until 2016 (the company can still underwrite risks arising in or from the U.S., which raises additional issues and questions that will be addressed later this week).  Also,  the minimum capitalization to start is less than half of Vermont, only $120,000.  [9]

And yet still other domiciles such as St. Lucia, offers initial capitalization requirements as low at $50,000. [10] Additionally, here annual operating fees can be as low as, $2,500 annually. [11]

Some other annual costs and fees (approximately) that may be necessary for consideration, whether forming an insurance company either offshore or domestically, including, but not limited to:

• captive manager ($10,000-$150,000)
• registered agent ($100-$5,000)
• actuary, ($5-50,000)
• auditor, ($5-25,000)
• asset manager (10-40 basis points)
• legal counsel ($100-500 + per hour).

“Operating expenses can vary significantly from one domicile to another, but it is not unusual for the cost of services such as captive management, audit and legal fees, and others to be as much as 10-20% more in some of the more established offshore domiciles.” [12]

Nevertheless, costs and fees are only one of many considerations for a proper domicile when forming an insurance company and a full examination of insurance needs should be weighed.  A list of some of these considerations can be found on our earlier blogticle Captive Insurance Companies Introduction September 1.

Tomorrow’s blogticles will discuss taxation of international insurance companies.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] About Vermont Captive.  http://www.vermontcaptive.com/about-us.html.  Posted 1997.  Last Accessed 9/27/2010.

[2] Vermont Captive Fees and Taxes.  http://www.vermontcaptive.com/regulations/fees.html.  Posted 1997.  Last Accessed 9/27/2010.

[3] Title 8 Vermont Statutes Annotated Chapter 141. “Captive Insurance Companies.” http://www.vermontcaptive.com/regulations/laws.html.  Last Accessed 9/28/2010.

[4] Vermont Captive Fees and Taxes.

[5] 3 Asset Protection: Dom. & Int’l L. & Tactics § 41:15.  Duncan E. Osborne and Elizabeth Morgan Schurig.  (2010).  Westlaw.

[6] Freedom In Captivity:  The Captive Insurance Legislation  of Nevis,  Jan Dash, Esq., Herman W. Liburd citing, International Association of Insurance Supervisors, Issues Paper on the Regulation and Supervision of Captive Insurance Companies, October, 2006, p. 50.; A Guide to Captive Insurance (Part 1), William Elliot, Journal of International Taxation, April, 2005.

[7] Inurance Managers Association of Cayman.  http://www.caymancaptive.ky/.  Updated 6/30/2010.  Last Accessed 9/27/2010.

[8] Cayman Islands Monetary Fee Schedule Effective January 1 2010.

[9] 2nd Annual Risk Management Captive Domicile Roundup.  Risk Management.  http://www.accessmylibrary.com/coms2/summary_0286-18713728_ITM.  Last Accessed 9/27/2010.

[10] Pinnacle St. Lucia.  http://www.saintluciaifc.com/online_registry/fees.htm.  Last Accessed 9/27/2010.

[11] Id.

[12] Wilmington Trust. “Captive Insurance Companies.” http://www.captive.com/service/WilmingtonTrust/images%20and%20pdf/captive101whitepaper.pdf.  2008.  Last Accessed 9/28/2010.

Why is this Topic Important to Financial Professionals? Although the Captive Insurance Company is far from a new concept, it is certainly being discussed once again this fall.  The complicated subject, however, is logical and can be broken down.  Repetitive exposure to the ideas will help the financial professional incorporate alternative risk transfer prerogatives, such as captives, into their clients’ financial plans.

A traditional “single parent” Captive Insurance Company, or sometimes known as a captive, is defined as, “[a] closely held insurance company whose insurance business is primarily supplied by and controlled by its owners, and in which the original insureds are the principal beneficiaries.”[1] The single parent means the ownership of the insurance company is controlled by one company.  “A captive insurance company’s insureds have direct involvement and influence over the company’s major operations, including underwriting, claims management policy and investment.”[2]

A captive insurance company could write a variety of business depending on the jurisdictional restrictions, which brings up another interesting point.  Some financial professionals may know that captives can be formed here in the United States, Vermont for example, as well as foreign jurisdictions; popular jurisdictions for some forms of underwriting are Bermuda or the Cayman Islands.  Considerations for choosing a jurisdiction to domicile a captive can include a number of factors, including but not limited to:

• Types of underwriting permitted, for example life and/or casualty
• Capitalization requirements
• Investment and reserve requirements
• Manager and meeting requirements
• Fees
• Premium and/or underwriting taxes

Federal insurance taxation will also be an issue for the owner of an insurance company.  Depending on a number of factors such as ownership considerations, and underwriting types and premiums collected each year, the tax status of the company could change.  Another common issue surrounding captive insurance companies and taxation is, risk shifting and risk distribution.  Together these topics are detailed and go beyond the purview of today’s introduction.

However, some financial planners have found group captives to be helpful.  Generally, a number of group captives can provide similar benefits a single parent captive, but usually have an administrator who manages the underwriting, accounting, taxation and regulatory issues. These structures are similar to traditional mutual insurance companies.  A financial planner can also hire an attorney or third party administrator to manage a single parent captive for a client from the formation process through dissolution.

“These guys were discussing captives with me five years ago, but I didn’t quite understand the concept enough to present to my clients,” says Martin E. Levine, ChFC, MBA, CPA.  Mr. Levine is an author and principal of Macro Financial Services, a financial planning firm for wealthy individuals on Long Island, New York.  “Now, I see [captives] as a very useful tool to reach some of my clients’ planning objectives.”  He continues, “the actual benefits to clients from implementing certain practices has shown to be significant.”[3]

There are a number of different solutions available to businesses of all size.  From companies such as Ford or UPS, to small neighborhood businesses, captive insurance options are available, in that operational risk will always be present, a good risk management plan will generally consider some forms of alternative risk transfer.

Tomorrow’s blogticle will discuss reinsurance and how it is commonly used in alternative risk transfer.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Captive Insurance Company Glossary. Pg 3.  Towers Perrin.  Captive.com. http://www.captive.com/service/TowersPerrin/images%20and%20pdf/Captive%20Glossary%20TP.pdf. Last Accessed 8/26/10.

[2] Id.

[3] Interview.  Martin Levine.  July 2010.  http://macrofinancialservices.com/