Captive Presentation 3 2 11

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					   CAPTIVE INSURANCE COMPANIES




March 2, 2011   Presentation for Estate Planning Council of Delaware, Inc.
       Captive 101
1



       What is a Captive?

          “Wholly owned subsidiaries created to provide insurance to the parent companies” (AICPA Audit
           and Accounting Guides)
          A form of alternative risk financing
          A formalized form of self insurance




2011
       Captive 101
2



       Who Uses Captives?

          Publicly Traded Companies
          Large and mid-size privately held organizations
          Large and mid-sized tax exempt organizations
          Associations or groups of individuals or small organizations
          Wealthy individuals
          Insurance agents or brokers


       General Characteristics of Captive Prospect (at least one):

          Revenue > $25mm
          EBIT > $1.5mm
          Current Insurance Premium > $200k



2011
       Captive 101
3



       Common Captive Coverage
          All Risk Property
          Construction Defect / Mold
          Director and Officer
          Employee Benefits
          Employment Practices
          General Liability
          Litigation Defense
          Product Liability
          Professional Liability (including Medical Malpractice)
          Warranty
          Workers Compensation
          Exclusions / Deductible Reimbursement / Differences in Conditions and Limits (DIC/DIL)




2011
       Captive 101
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       Captive Benefits

          Regulate corporate deductibles and Self-insured risks
          Coverage availability
          Direct access to reinsurance markets
          Improve claims handling and data collection process
          Centralize risk management
          Reduced insurance costs – short and long term
          Stabilize insurance budget
          Enhance balance sheet
          Profit center creation – source of new revenue
          Realize possible tax benefits – cash flow maximization
          Wealth Transfer




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       Captive 101
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       Types of Captives


          Single parent / pure captives: A captive with one corporate owner, insuring principally only the
           risks of the parent organization or its subsidiaries

          Group captives: A captive having two or more owners, typically members of an industry trade
           association

          Risk retention groups: An insurer formed under Federal Law governed by the laws of any U.S.
           state, whose primary activity is assuming and spreading all liability coverages except workers
           compensation and personal risk liability. An RRG must be owned by its policyholders, and its
           policyholders must be insured by the group.

          Reciprocals: An unincorporated association facilitating an exchange of insurance contracts,
           whereby individuals or entities undertake to indemnify each other against specified kinds of losses.




2011
       831(b) Small Insurance Company
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       Internal Revenue Code Section 831(b)

          Small property and casualty insurance company provisions
              Net written premium less than or equal to $1.2 million

          Requirements
              Legal entities (7 – 12 is considered minimum safe harbor) (Revenue Ruling 2002-90); or
              Third party risk (risk pools) (Revenue Ruling 2002-89)
              Identifiable / quantifiable insurance risk
              Arms-length premiums
              Risk transfer
              Operate as an insurance company

          Results
              Deduction for annual premiums paid to captive
              Captive taxed only on investment income (at corporate tax rates); not on premium income




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       831(b) Small Insurance Company
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       Standard 831(b) Structure

          Generally, a top tier wholly owned subsidiary, but…
          For wealth transfer, captive is owned by the adult children of the primary owner (directly or indirectly)
          Provides coverage to the subsidiaries and affiliates of the primary owner organization in exchange for
           a premium
          In most cases, insurance provided does not replace, but rather complements coverage purchased
           from the commercial market therefore not changing the overall risk exposure of the organization
              Deductibles or self-insured risks
              Conditions & Exclusions (i.e. DIC / DIL)
              Other risks where coverage is not available

          Premium determined by:
              Underwriters
              Actuaries
              Market quotes from independent carriers



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       831(b) Small Insurance Company
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       Standard 831(b) Structure

                                                   Irrevocable Trust
                                  $250k Gift
                                                      / Individual /
                Owner                                 Trust/LLC/LP
                                                   Holding Company
               (Parent)                                / Family LP
                                                    DST/Individuals
                                                        (Children)


          Voting   Non-Voting
                                                   Ownership $250k capital
                                                             Contribution
                                                                                                (If necessary)

                                Premiums Paid
                                                                             Third Party Risk
                                                         Captive
            Company &
                                                        Insurance                                          Pool
             Affiliates
                                                        Company

                                Insurance Policy                             Transfer Risk




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       831(b) Small Insurance Company
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                                  Example Coverage Prior to Captive Implementation




        Property Program
         $100,000,000


                                                               D&O Clauses     Entity
                                                                  A&B        Coverage     Bankers                  F.I. Bond            Umbrella
                                                                 $40mm        $40mm     Professional Employment     $40mm Mortgage Liability
                                                                                          Liability   Practices    (various) Protection $25mm
                             Business                                                     $10mm        Liability              $10mm
                              Income                                                                   $10mm
                             $2.5mm               Flood &
                               Extra             Earthquake
                             Expense               $5mm
                              $10mm BI Sublimits
       Deductible $100,000                                                               Deductible                                     General Terrorism
                                                               D & O Deductible $1mm    Each Clause                                     Liability Deductible
                                                Various            & $2.5mm for           $2mm           $350m     $1mm                 & Auto
                                                Deductibiles         Securities                       $500m Class Deductible            $1mm
                                                                                                         Action                $20k      each




2011
       831(b) Small Insurance Company
10

                Example Coverage Post Captive Implementation




2011
       831(b) Small Insurance Company
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       Estate Planning Benefits

          Shift potential profit to next generation
          Keep full control over the business
          Wealth Transfer is achieved with each premium payment made
          Business Succession can be achieved by adding key executives to the ownership structure
          Income tax minimization / Wealth maximization
          Frees up liquidity



       Other Benefits
          Asset Protection – not available to general creditors of business
          Assets potentially not restricted by debt covenants of business (ordinary and necessary expense
           exclusions)




2011
          831(b) Small Insurance Company
    12


    Shift potential profit to next generation
    Keep full control over the business
    Wealth Transfer is achieved with each premium payment made
                                                       Delaware                    Delaware Directed
                                                         Asset                     Trust for Children
                     Owner                             Protection                  and Grandhildren
                                                         Trust                         of Owner
                    (Parent)         $250,000          1% managing                     99% non-
                                    investment           interest                      managing
                                                                                        interest
     Traditional                                                          Family
     Insurance                                                             LLC
     Company
                                                       $250,000 capital            Dividends   paid

                                 $1.1 M premium annually              Captive
                   Company &                                         Insurance                        After 10 years,
    Insurance                                                                                         gain of $7.9 M
     for third      Affiliates           Policy insuring
                                                                     Company
    party risks                         manageable risks
                                                                   Investments


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       831(b) Small Insurance Company
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      Business Succession can be achieved by adding key executives to the ownership structure
      Income tax minimization / Wealth maximization
      Frees up liquidity

                                                                                 Key
                                                                                Execs
                   Owner                     $250,000
                                            investment
                                                                                 LLC
 Tax benefits                                                $250,000 capital
 can be used
                                                                                        Dividends   paid
 to purchase
life insurance
       on
 owner/execs                                                             Captive
                                   $1.1 M premium annually
                                                                        Insurance                          LLC
                 Company &                                              Company
                                           Policy insuring
                  Affiliates              manageable risks                                              Life Insurance
                                                                      Investments                        Policies on
                                                                                                       Owner and Execs



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       831(b) Small Insurance Company
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      Bringing it all together – Utilizing a Delaware Series Entity

                                                                                    Delaware
             Owner                                                               Directed Trust
                                                                        Family   for Children of
            (Parent)                                                     LLC         Owner

                                               Series Business Unit A

                                $1M           Delaware Series
                             premiums          LLC Captive
                                                 Insurance
          Company &                              Company
                                   $1M
           Affiliates           premiums
                                              Series Business Unit B

                                                                          Key
                                                                         Execs
                                                                          LLC


2011
       831(b) Small Insurance Company
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       831(b) Captive Case Study

          Captive owned by adult children of business owner
          Located in a recognized domicile
          Considered an insurance company for tax purposes
          Provides deductible, difference in conditions, difference in limits coverage on a direct basis under
           the All Risk Property, Umbrella and Pollution Liability policies
          Premiums are derived on arms-length basis by third party actuary
          “Affiliates” pay roughly $1.1 Million in premiums to the captive
          Captive incurs $160k and $80,375k in claims and operating expenses respectively




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       831(b) Small Insurance Company
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       831(b) Captive Case Study – Anticipated Captive Costs

              Implementation                                                          Recurring
                         30,000            Captive Manager                                  30,000
                         10,000            Actuary                                          10,000
               25,000 – 65,000             Audit & Tax Advisor                              25,000
                         12,500            Risk Manager / Underwriter                         7,500
                 3,000 – 6,000             Legal Fees                                         2,500
                                0          Premium Tax                                        5,000
                 3,200 – 5,000             Annual Licensing                                       375
             81,200 – 131,000              Total                                  $         80,375 *



          * Risk pool is an additional cost estimated at 3-5% of annual premium




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       831(b) Small Insurance Company
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       831(b) Captive Case Study – Operating Results and Tax Implications

                    Affiliates                                                   Captive
                 $ (1,100,000)              Premium Paid                     $      1,100,000
                                            Incurring Insurance Losses              (160,000)
                                            Operating Expenses                       (80,375)
                                            Investment Income                         70,000
                 $ (1,100,000)              Net Income / (Loss)          $           929,625
                $      (110,000)            State Income Tax (10%)*      $                  -
                       (346,500)            Federal Income Tax (35%)                  24,500 **
                $      (456,500)            Net Tax Impact               $            24,500


            *Average Subsidiaries state tax rate

            **Captive is taxed on Net Investment Income only




2011
           Will the captive hold up?
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      Tim Collins, until recently the IRS Captive Industry Specialist, posed the following sample audit questions:
          Are the risks garden-variety or unique risks that require further investigation?
          Was a feasibility study performed showing business benefits?
         Does the assuming company have the capacity to assume the risk? Look at the premium to surplus ratio. Are there
       parental guarantees? What is the maximum single risk exposure compared to surplus?
         Is the insured substantially paying for its own losses. Compare the relationship of the largest insured as measured by
       premiums to total premiums.
          Are there sufficient exposure units for risk to be reasonably predictable?
           Is the captive operating as an independent entity and is there insurance in its generally accepted sense? (Could captive
       still function if its largest investment failed?)
         Is there a loss portfolio transfer and is there a significant change of a significant loss as required for GAAP under FASB
       113?
          If parent premiums are deducted, is there a sufficient amount of unrelated risk assumed by the captive?
         Is the taxpayer taking a consistent position by paying excise tax for risk ceded to an offshore insurance company that is
       not taxed as a U.S. taxpayer?
         Did the captive enter into a finite risk contract with an offshore reinsurance company that is a non-controlled foreign
       corporation? Is there significant tax avoidance?
          Are captive assets used as security or as a compensating balance for the liabilities of another entity?



2011
       Captive Implementation and Formation
19



       Captive Program Design Life Cycle

          Analysis of current insurance program                                1 – 3 Weeks
          Pre-feasibility study – identify goal and service providers          1 – 3 Weeks
          Initial testing of reinsurance and fronting markets (if necessary)   2 – 4 Weeks
          Feasibility Study – includes actuarial, accounting and tax review    45+/- Days
          Domicile analysis                                                    1 Week
          Go / No-Go decision
          Corporate risk management restructuring (if necessary)
          Captive application and formation                                    30 – 45 days
          Captive commences insurance operations




2011
       Service Provider Selection
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       Required Providers

          Attorney
          Captive Manager
          Actuary
          Audit & Tax Advisory
          Bank
          Underwriter / Risk Manager

       Additional Providers

          (Re)Insurance Broker / Intermediary
          Third Party Administrator
          Investment Manager / Advisor
          Consultants


2011
       Contacts
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       Mary Alice Avery
       Wilmington Trust
       302.636.6127
       mavery@wilmingtontrust.com



       Trisha W. Hall, Esquire
       Bayard, P.A.
       302.429.4225
       thall@bayardlaw.com




2011

				
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