Captive Insurance
Environment and Middle Market
Update/Activity
Society of Risk Management Consultants
April 8, 2016
Panelists
Patrick Theriault
Managing Director, Strategic Risk Solutions
Charles (Chaz) Lavelle Bingham Greenebaum Doll LLP
SRMC Spring 2016
Atlanta - April 8th
2
Presentation Outline
 Captive Insurance – The Basics
 Market Update
 Insurance Company Taxation
o The Foundation
o Latest Developments with Small Captives
 Typical Structures and Case Studies
 Q&A
SRMC Spring 2016
Atlanta - April 8th
3
Captive Insurance – The Basics
SRMC Spring 2016
Atlanta - April 8th
4
Captive Insurance – The Basics
Retain
Unfunded
Pure Self-Insurance
Pre-Loss
Funded
Pure Captive/Rent-A-Captive
Post Loss Funded
 Credit Line
 Contingent Plan
Association/Group Captive
Risk
Financing
Framework
Share
Risk Retention Group
Group Buying/Self-Insured Group
Non-Insurance
Agreements
 Indemnification
Agreements
 Hold Harmless
Agreements
Insurance
 Guaranteed Cost
 Loss Sensitive Plans
Transfer
SRMC Spring 2016
Atlanta - April 8th
5
Captive Insurance – The Basics
Definition:
A closely held insurance company that is owned
and controlled primarily by its insureds
Characteristics
 A licensed insurance company
 Formed to insure or reinsure the risks of its owners or
related parties of their choosing
 Regulated under special legislation regulating captives
 Located onshore or offshore
 Generally licensed in only one domicile
SRMC Spring 2016
Atlanta - April 8th
6
Captive Insurance – The Basics
Why Captives are Formed?
 Reduce Cost of Risk
 Increase Control
 Lack of Available Coverage or Breadth of Coverage
 Industry Bias (medical malpractice, trucking, etc…)
 Entrepreneurial Opportunities (third party risk)
 Tax Liability Management
 Complete insulation/separation from the commercial insurance
market is challenging due to capital requirements.
SRMC Spring 2016
Atlanta - April 8th
7
Captive Insurance – The Basics
Large
Single Parent Captive
Size
of
Insured
Medium
Small
Insurance
Company*
Small
Rent-ACaptive
Group Captive, RRG
*Small captives (aka 831b) have become popular with smaller entities
SRMC Spring 2016
Atlanta - April 8th
8
Captive Insurance – The Basics
 Formation Timeline:
o Feasibility/structuring:
30-365 days
o Implementation:
30-90 days
 Formation Costs:
$35,000 - $100,000+
 Ongoing Operating Costs:
$55,000 - $150,000+
SRMC Spring 2016
Atlanta - April 8th
9
Market Update
SRMC Spring 2016
Atlanta - April 8th
10
2015 Captive Industry Review

Captive industry growth slowed slightly in 2015 but remains strong at 4.8%.
This compares to 8.6% in 2014. 498 new captive formations and a net
addition of 202 (100 net increase worldwide according to Business
Insurance Survey).
o Slow down in small captive growth due to IRS scrutiny and uncertainty over the
831(b) election.
o More cell formations than standalone captives.

Closures were significantly higher this year, up 75.1% from 2014. Reasons
for this include:
o Re-domestications (reported in domicile figures).
o Parent organization consolidations, especially in the healthcare industry.
o Some small captives closures due to parent company acquisitions, concerns
over IRS scrutiny and market conditions.
o Soft commercial market conditions, primarily affecting group captives and RRGs.
SRMC Spring 2016
Atlanta - April 8th
11
Domicile Review
2015 SRS Prediction
 Home states with captive laws and receptive regulators will continue
to grow – established domiciles will hold their own.
2015 Activity
 The growth rate of 4.8% is consistent with the growth rate we have
seen outside of the emerging domiciles in recent years.
 New formations, including re-domestications, were down 5.5%. New
formations have decreased for the past two years after several
years of increases.
 Growth continued to be driven by small captives and cells with
highest growth totals seen in domiciles attracting these structures.
SRMC Spring 2016
Atlanta - April 8th
12
Total Active Captives
2015
2014
Bermuda
797
800
Cayman
708
759
Vermont
596
587
Utah
450
422
Delaware
323
333
Nevada
202
160
Hawaii
197
194
Montana
196
177
DC
193
191
South Carolina
167
158
Tennessee
127
70
%
change
2015
2014
%
change
110
114
-3.5%
94
52
80.8%
92
122
-24.6%
73
47
55.3%
-3.0% Missouri
26.3% Alabama
50
47
6.4%
42
40
5.0%
1.5% Michigan
10.7% New Jersey
23
15
53.3%
22
17
29.4%
1.0% Texas
5.7% Connecticut
21
12
75.0%
10
7
42.9%
6,939
6,839
1.5%
-0.4% Arizona
-6.7% North Carolina
1.5% Kentucky
6.6% Oklahoma
81.4% Total
Figures per Business Insurance Survey
SRMC Spring 2016
Atlanta - April 8th
13
New Captive Formations
2015
2014
Bermuda
22
16
Cayman
22
22
Vermont
33
16
Utah
66
106
Delaware
48
87
Nevada
50
26
Hawaii
19
15
+4 New Jersey
Montana
39
34
+5 Texas
South Carolina
30
20
5
5
57
42
DC
Tennessee
change
2015
2014
change
7
13
-6
42
49
-7
1
0
+1
26
37
-11
-39 Missouri
5
12
-7
+24 Michigan
8
9
-1
5
3
+2
10
12
-2
3
3
0
498
527
-5.5%
+8 Arizona
0 North Carolina
+17 Kentucky
-40 Oklahoma
+10 Connecticut
0 Total
+15
Including re-domestications
Figures per SRS Survey
SRMC Spring 2016
Atlanta - April 8th
14
Captive Closures
2015
2014
change
2015
2014
change
Bermuda
22
47
-25 Arizona
11
5
+6
Cayman
74
21
+53 North Carolina
1
0
+1
Vermont
28
12
+16 Kentucky
31
6
+25
Utah
38
26
+12 Oklahoma
0
0
0
Delaware
22
20
+2 Missouri
4
0
+4
Nevada
4
9
-5 Michigan
1
0
+1
Hawaii
16
5
+11 New Jersey
1
0
+1
Montana
19
7
+12 Texas
1
0
+1
South Carolina
19
5
+14 Connecticut
0
0
0
DC
2
6
-4 Total
296
169
75.1%
Tennessee
2
0
+2
Including re-domestications
Figures per SRS Survey
SRMC Spring 2016
Atlanta - April 8th
15
Cell and Series Captives
2015 Prediction
 Continued captive growth to be driven by small captives and cells.
2015 Activity
 The expansion in cell and series LLC legislation creating separate legal
entities at the cell/series level has blurred the lines between standalone
captives and cells/series.

Delaware legislation gives series equal recognition as a captive insurance
company.
 2015 saw the first court case involving a cell (Pac Re 5-AT v. AmTrust
N.A.). The Montana court upheld the cell structure.
 With similar benefits available in a cell/series many owners are going
this route rather than forming standalone captives.
SRMC Spring 2016
Atlanta - April 8th
16
Cell and Series Captives (Continued)
Cells at
12/31/2014
Net
Additions
Cells at
12/31/2015
Captives + Cells
at 12/31/2015
Cayman
606
-3
603
1,310
Delaware
624
78
702
1,061
Tennessee
206
98
304
430
North Carolina
120
120
240
334
Vermont
78
12
90
678
Utah
71
-3
69
516
Total
1,705
282
2,011
3,149

The growth in number of cells and series in 2015 across these six domiciles alone
exceeded captive growth. Cells and series are growing at much faster rate. This trend
is likely to continue as domiciles compete on legislation.
Figures per SRS Survey
SRMC Spring 2016
Atlanta - April 8th
17
New and Emerging Domiciles

We continue to see interest in home state re-domestications with more
domicile choice and greater awareness of self-procurement tax.

The newer domiciles are gaining traction particularly among home state
parent organizations.
o Texas now has 21 captives and expanding among Texas businesses. Broadened
the captive law in 2015.
o Connecticut has 10 active captives and expect expansion among Connecticut
companies, protected cells and medical stop loss programs.

New domiciles continue to enter the captive market.
o Georgia updated its captive law in July to reactivate its captive industry
particularly for Georgia captive owners.
o Arkansas recently licensed its first special purpose captive.
SRMC Spring 2016
Atlanta - April 8th
18
Small Captives
2015 Prediction
 Continued captive growth to be driven by small captives and
cells…… unless material negative changes result from recent
section 831(b) amendments.
2015 Activity
 Small captives continued to account for a significant portion of the
industry’s growth in 2015.
 Formations slowed in 2015 as some potential owners waited for the
outcome of potential changes to the 831(b) provisions and general
uncertainty about the environment with increased IRS scrutiny.
SRMC Spring 2016
Atlanta - April 8th
19
Medical Stop Loss Captives
 2015 saw continued growth for both single parent and group MSL
captives, both heterogeneous and homogeneous.
 We are seeing an increase of larger mid-size employers (250 EE –
1,000+) joining group captives (part of an already established
consortium, association or homogenous group – RRG’s).
 The use of captives for voluntary employee benefit plans:
o To mitigate the financial gaps being created by the movement to high
deductible health plans, products like group critical illness, group
accident, hospital indemnity plans, etc. are being introduced by plan
sponsors large and small. This is driving captive owners to again
consider expanding use of captives to include these types of voluntary
employee benefit plans.
SRMC Spring 2016
Atlanta - April 8th
20
2016 Market Trends/Predictions

General slowdown driven by
o Continued soft market.
o Healthcare sector still difficult for captives.
o Year of review, restructuring and re-start for small captives (significant time
demand for all involved).
o Offset in part by continued interest in Medical Stop Loss and specific sectors
such as Transportation.

Home state preference leading to continued growth in newer domiciles and
some re-domestications.

Quieter Federal Regulatory Environment after a busy year – Election year.

Difficult investment environment.

Number of captives considering service provider change to increase.
SRMC Spring 2016
Atlanta - April 8th
21
Insurance Company Taxation
SRMC Spring 2016
Atlanta - April 8th
Deductibility of Future Payments for Claims
 A business can only deduct payments for damages
caused to others upon payment.
 An insurance company can estimate its future
payments for losses and currently deduct their
present value.
 Thus, if one anticipates a loss of $1,000,000 that will
have to be paid in 10 years, a business cannot
deduct it until payment is made in year 10, but an
insurance company can deduct most of it in year 1.
 Thus, there is a tax advantage if a business sets up
a captive.
SRMC Spring 2016
Atlanta - April 8th
Captive Principles from 100,000 Feet
1) Captives should only be formed for non-tax
business purposes and should only retain a
comfortable level of risk and volatility.
2) The owners must want to be in the insurance
business (willing to assume and share
insurance risk).
3) The captive must be operated as an insurance
company (observing formalities and operating
at arms length with the insureds).
SRMC Spring 2016
Atlanta - April 8th
Captive Tax Parameters
 Single Parent vs. Group Captive.
 Foreign Captive vs. Domestic Captive (including
a captive electing to be taxed as a domestic).
 Taxable environment vs. Tax exempt
environment.
SRMC Spring 2016
Atlanta - April 8th
Prerequisites for finding “insurance” for tax
purposes – some courts
 Have a non tax business purpose for
establishing the captive.
o See the discussion in the Feasibility Session.
 The arrangement cannot be a sham.
o Purpose other than tax benefits.
o Proper documents.
o Actions comport with the documents.
SRMC Spring 2016
Atlanta - April 8th
Court tests for “insurance” for Federal income
tax purposes
 The most recent Tax Court decisions have
required the following to find “insurance” for
Federal income tax
o
o
o
o
An Insurance Risk must be involved.
Common Notions of Insurance.
Risk Shifting.
Risk Distribution.
SRMC Spring 2016
Atlanta - April 8th
Insurance Risk
 Insurance Risk.
o There must be a realistic chance that a loss will occur
(it cannot be speculative).
o There must be a chance that a loss will not occur
(there must be some fortuity).
o It differs from a business risk.
o It differs from an investment risk.
SRMC Spring 2016
Atlanta - April 8th
Risk Shifting
 Risk Shifting (from Rev. Rul. 2002-91).
o Risk Shifting occurs if a person facing the possibility
of an economic loss transfers some or all of the
financial consequences of the potential loss to the
insurer, such that a loss by the insured does not affect
the insured because the loss is offset by the
insurance payment.
o If an insured insures it automobile with an insurance
company, then the insured is indifferent FROM A
FINANCIAL STANDPOINT as to whether the insured
wrecks the automobile.
SRMC Spring 2016
Atlanta - April 8th
Risk Shifting
Risk Shifting is often met if
o The captive is well capitalized.
o No one guarantees the performance of the captive.
SRMC Spring 2016
Atlanta - April 8th
Risk Shifting Fact Situations
 #1 – X is an offshore captive with $24,000 of capital and
$1,200,000 of premiums (a 50 to 1 premium to surplus
ratio); a typical premium to surplus ratio is closer to 3:1.
Is there risk shifting? What effect if the regulator
approved the arrangement?
 #2 – Same as #1, except the capital was $400,000 (3:1
premium to surplus ratio.)
 #3 – Same as #1, except the captive is a cell, rather than
a stand-alone captive.
SRMC Spring 2016
Atlanta - April 8th
Risk Distribution
 Risk Distribution requires a sharing of risks.
 There must be sufficient exposure units.
 The IRS believes it also requires that there be
many insureds.
 One test sometimes used is that an insured not
pay its own losses.
SRMC Spring 2016
Atlanta - April 8th
Risk Distribution in the Courts
 The courts have found that risk distribution
existed in either of two scenarios:
o Sufficient outside business.
o “brother-sister” insurance.
• Rev. Rul. 2002-90-12 entities each between 8-15% of total
premium
• Rent-A-Center & Securitas cases appeared to look to
exposure units more than entities
SRMC Spring 2016
Atlanta - April 8th
Risk Distribution Through Third-Party
Insurance (1)
Third-Party or Outside Insurance
Parent
100 %
100 %
Unrelated
Insureds
Insurance
Insurance
Insurance
Subsidiary
Insurance
Operating
Subsidiaries
SRMC Spring 2016
Atlanta - April 8th
Risk Distribution Through Third-Party
Insurance (4)
The Courts of Appeals have also ruled for the taxpayer
in four “outside” business cases: Sears, Amerco,
Harper Group and Ocean Drilling. The lowest amount
of outside business in these cases was 29%.
Rev. Rul. 2002-89 ruled that there was no insurance of
the parent where 90% of the captive’s premiums were
from the parent, but there was parent insurance
where less than 50% of the captive’s premiums were
from the parent.
SRMC Spring 2016
Atlanta - April 8th
Rev. Rul. 2002-89 –
Assumes all other facts are “plain
vanilla”
Not
Insurance
Insurance
Parent
Parent
100 %
ownership
Unrelated
Insureds
90%
of the
Premiums
Captive
10% of the
Premiums
100 %
ownership
Unrelated
Insureds
less than
50% of the
Premiums
Captive
More than
50% of the
Premiums
SRMC Spring 2016
Atlanta - April 8th
Third Party Business – How do you find it ?
 There are several sources of unrelated business.
 Some brokers, captive managers, etc. will develop
“pools” wherein captives reinsure a pro-rata portion
of the risks of a number of the sponsor’s customers.
 Similarly, a captive may reinsure a commercial
carrier.
 Owners or General Contractors may create a
captive to insure all the contractors on a major
construction project.
 Customers, franchisees, suppliers, etc. Are also
sources of unrelated business.
SRMC Spring 2016
Atlanta - April 8th
Pooling
 There are different ways to design pools (assume A owns A
Co [an operating company] and A Captive; the same for B, C,
… Z; each Co pays the same premium):
o A Co, B Co, C Co, etc. insure with a fronting company
which reinsures an equal share with each Captive.
o A Co insures with A Captive; A Captive reinsures with
Pooling Co., as do B Captive, C Captive, etc. Pooling Co.
re-reinsures an equal share to each of the captives.
o Same as above, except that instead of reinsuring and rereinsuring with Pooling Co, it is done with contracts.
 There is non-precedential IRS authority for most pooling
situations.
SRMC Spring 2016
Atlanta - April 8th
Risk Distribution Through
Brother-Sister Insurance (1)
“Brother-Sister” Insurance
Parent
100%
Insurance
Subsidiary
Oper.
Sub
100%
100%
100%
Oper.
Sub
100%
Oper.
Sub
100%
Oper.
Sub
Oper.
Sub
Insurance
SRMC Spring 2016
Atlanta - April 8th
How Many Insureds ? (1)
Rev. Rul. 2005-40 ruled that if there is only one
insured, there can never be risk distribution,
even if the insured and insurance company are
unrelated, the insurer is adequately capitalized
and all aspects of the relationship are done at
arms-length.
Rev. Rul. 2005-40 also ruled that there can never
be risk distribution, if there are two insureds, one
with 90% of the insurance and the other with
10%.
SRMC Spring 2016
Atlanta - April 8th
How Many Insureds ? (2)
In Rev. Rul. 2002-90 found risk distribution present
where there were 12 subsidiaries, none of which
had less than 5% nor more than 15% of the
captive’s risks, and the captive had a significant
volume of independent, homogenous risks.
In the 2014 cases of Rent-A-Center and Securitas,
the Tax Court seemed to rely on sufficient
exposure units (e.g. 15,000 employees, 7,000
vehicles and 3,000 stores), rather than the
number of insured entities or concentration of
risks in one subsidiary.
SRMC Spring 2016
Atlanta - April 8th
Disregarded Entity an Insured? (1)
Do “Pass Through” Entities Count as Insureds?
A single member LLC (SMLLC) is generally
disregarded for income tax purposes unless it
elects to be treated as a corporation. If the
owner is a corporation, the LLC is treated a
division. If the owner is an individual, the LLC is
treated as a proprietorship.
The IRS believes that a disregarded SMLLC is not
an insured, but its owner is the insured (Rev.
Rul. 2005-40).
SRMC Spring 2016
Atlanta - April 8th
Insurance Distribution Fact Situations
 #1 The captive issues insurance policies to 15 “brother-sister”
affiliates that own no stock in the captive. One subsidiary
pays 15% of the premium. The rest are between 5 and 15%
of the premium. Is there risk distribution?
 #2 The same as #1 except one operating subsidiary pays
60% of the premium, and there are 5 other subsidiaries that
each pay 8% of the premium. Is there risk distribution?
 #3 Y operating company buys insurance from its captive,
which also participates in a pool. The captive reinsures 51%
unrelated business of the same kind of risks as the related
party risks. Is there risk distribution?
 Same as #3, except the unrelated business is 10%.
SRMC Spring 2016
Atlanta - April 8th
Common Notions of Insurance (2)
In short the captive should act like a “real” insurance company,
including:
o Reasonable capitalization; no parent guarantee
o Reasonable premiums (can there be retrospective premiums?)
o Standard policy forms (can there be retroactive insurance?)
o Reasonable reserves
o Risk distribution (homogenous risks? From multiple states?)
o Standard investments (are related-party loans permitted?)
o No commingling of assets with the insureds
o Maintain corporate formalities
o Independent operation
o Separate letterhead, etc.
o Reasonable regulation?
o Licensed in all jurisdictions where the risks are located?
o Non-tax business purpose
SRMC Spring 2016
Atlanta - April 8th
Loan Backs
Standard Investments
 Insurance companies often match the maturities of their
investments with the anticipated timing of claims
payments. The favorable Revenue Rulings in 2002 and
2005 assumed that there were no inter-company loans.
 In Notice 2005-49, the IRS has asked for comment on the
significance, if any, of loans by the captive to related
parties. The industry responded.
 Commercial insurance companies cannot loan a
significant portion of its assets to a single company.
 In non-precedential documents, the IRS has often found
that insurance was not present when there were large
loan backs.
SRMC Spring 2016
Atlanta - April 8th
Section 501(c)(15) and 831(b) Companies
(1)
 Sections 501(c)(15) and 831(b) provide favorable tax
treatment to small insurance companies. Insurance
companies qualifying under section 501(c)(15) are completely
exempt from income tax. In response to perceived abuses of
the section 501(c)(15) rules, the statute was tightened in
2004.
 Today, a stock P&C company and companies under common
control with it cannot have gross receipts in excess of
$600,000; more than 50% of the gross receipts must be
premiums. (Mutuals cannot exceed $150,000 of gross
receipts, at least 35% are insurance premiums.) See Notice
2006-42 concerning the measurement of gross receipts.
SRMC Spring 2016
Atlanta - April 8th
Section 501(c)(15) and 831(b) Companies
(2)
 Insurance companies qualifying under section 831(b) may elect to
be taxed on their “taxable investment income” only. Section
831(b) companies are those where the greater of net written
premiums or direct written premiums is not more than $1,200,000.
In 2017, the limit increases to $2,200,000 and is indexed.
 The premiums are counted on a controlled group basis with 50%
ownership (not 80%) the threshold to be included in the group.
 Once made, the election is irrevocable, unless the IRS consents.
 The downside is that underwriting losses cannot offset investment
income and there are limits on net operating losses carried to or
from another year.
SRMC Spring 2016
Atlanta - April 8th
Group Captives (1)
Even in the early years, the IRS consistently
treated premiums paid to group captives as
deductible, if there were enough owners, no
insured dominated and the risks were shared in
a common pool.

Rev. Rul 2002-91 found insurance where no
member owned more than 15% of the group
captive, had more than 15% of the vote, nor
accounted for more than 15% of the risks
insured.
SRMC Spring 2016
Atlanta - April 8th
48
IRS Scrutiny
 There are anecdotal reports that the IRS is auditing a substantial
number of captives electing to be taxed under section 831(b)
 Tax Shelter Promoter Investigations:
o One or more captive managers are being investigated to determine if they
are tax shelter promoters
 Audits of Captives Electing Section 831(b) – some of them are
customers of the captive manager(s) under investigation and some
are captives associated with operating companies otherwise
selected for audit
 Just because the IRS is investigating an issue or conducting an
audit does not mean that anyone has done anything wrong
 There have been no results announced from the investigation(s)
SRMC Spring 2016
Atlanta - April 8th
49
Audits of Captives Electing Section 831(b)
 The audits are very exhaustive and usually include an
interview of the principal(s) and comprehensive
information requests
 Comprehensive information document requests:
o Information from the inception of the captive, even if it preceded
the years under audit
o All emails, marketing materials, etc.
o Comprehensive questions on how one got involved in the
captive and was consulted
o What commercial insurance was in place, what are the gaps and
exclusions, how the captive program fit
SRMC Spring 2016
Atlanta - April 8th
50
Audits of Captives Electing Section 831(b)
 Comprehensive Information Document Requests (cont):
o What is the operating company’s risk management program
o How were the premiums priced
o For the ten years prior to its inception, were there any losses that
would have been covered by the captive program had it been in
place
o What is the loss experience of the related party and pool
insurance
o What are the investments
SRMC Spring 2016
Atlanta - April 8th
51
IRS Scrutiny: The Dirty Dozen
In 2015 and 2016, the IRS identified Tax Shelters as one of its “Dirty
Dozen.” For the first time, captives electing section 831(b) were linked to
tax shelters.
 “The promoters assist with creating and “selling” to the entities often
times poorly drafted “insurance” binders and policies to cover ordinary
business risks or esoteric, implausible risks for exorbitant “premiums,”
while maintaining their economical commercial coverage with traditional
insurers.”
 “Total amounts of annual premiums often equal the amount of
deductions business entities need to reduce income for the year; or, for
a wealthy entity, total premiums amount to $1.2 million annually to take
full advantage of the Code provision. Underwriting and actuarial
substantiation for the insurance premiums paid are either missing or
insufficient.”
SRMC Spring 2016
Atlanta - April 8th
52
Avrahami v Commissioner
 Avrahami v Commissioner is the first case involving a
captive electing to be taxed under section 831(b)
o The briefs were just filed; an opinion is expected in 2016
 The IRS is arguing that the contracts did not have
“insurance risk” but rather investment or business risk.
o The IRS does not believe that economic substance is present in
the captive insurance arrangement and the arrangement
appears to be tax motivated.
o The captive also participated in a pool that insured against
terrorism, primarily against terrorism risks not available in the
commercial market.
SRMC Spring 2016
Atlanta - April 8th
53
Protecting America From Tax Hikes Act of 2015
 Protecting America from Tax Hikes of 2015 (HR
2029) which passed December 18, 2015
included changes to section 831(b):
o The maximum premium allowable for an insurance
company electing section 831(b) is increased to
$2,200,000, which will be indexed for inflation.
o However, there are tighteners
o The changes apply to taxable years beginning after
December 31, 2016
SRMC Spring 2016
Atlanta - April 8th
54
Protecting America From Tax Hikes Act of 2015
 To be eligible to make a section 831(b) election,
an insurance company must meet either of the
two following diversification tests:
o Test 1: No more than 20% from any one policy holder
• Premiums are the greater of net written or direct premiums
• Related insureds are treated as one policy holder
o Test 2: The same person owns the operating
company and the insurance company
• The details are more complex than the preceding
sentence
• There is a 2% de minimus tolerance for different
ownership
SRMC Spring 2016
Atlanta - April 8th
55
Protecting America From Tax Hikes Act of 2015
 The IRS can change the de minimus percentage
from 2%
 The IRS can require information annually about
these tests from each insurance company
SRMC Spring 2016
Atlanta - April 8th
56
Captive Structure 1
Son
Father
70%
ABC
Company
30%
Insurance
100%
ABC
Captive 1
Because Son owns more in Captive* [100%] than he owns in Business [30%],
Captive 1 is not eligible to make an election under section 831(b)
* subject to the 2% de minimus rule
SRMC Spring 2016
Atlanta - April 8th
57
Captive Structure 2
Son
Father
70%
ABC
Company
70%
30%
Insurance
30%
ABC
Captive 2
Because Son owns no more in Captive* [30%] than he owns in Business [30%],
Captive 2 is eligible to make an election under section 831(b)
* would also be subject to the 2% de minimus rule, if needed
SRMC Spring 2016
Atlanta - April 8th
58
Captive Structure 3
Son
Father
70%
ABC
Company
80%
30%
Insurance
20%
ABC
Captive 3
Because Son owns no more in Captive* [20%] than he owns in Business [30%],
Captive 3 is eligible to make an election under section 831(b)
* would also be subject to the 2% de minimus rule, if needed
SRMC Spring 2016
Atlanta - April 8th
59
Summary of Examples
Owner
Business %age
Owned
Captive %age
Owned
Captive 1
Father
70%
Son
30%
Eligible for
831(b) Election
No
100%
Captive 2
Yes
Father
70%
70%
Son
30%
30%
Captive 3
Yes
Father
70%
80%
Son
30%
20%
SRMC Spring 2016
Atlanta - April 8th
60
Mutual 4
A
B
C
D
E
F
G
H
I
J
K
L
A
Co
B
Co
C
Co
D
Co
E
Co
F
Co
G
Co
H
Co
I
Co
J
Co
K
Co
L
Co
Premium-8 2/3%
each insured
Mutual 4
12 corporations (A Co., B Co., C Co., etc.) insure with a mutual insurance company. A
owns A Co., B owns B Co., etc. A through L are unrelated. Each of the insureds pays 82/3% of the premiums. The mutual would meet the 20% diversity test because no policy
holder pays more than 20% of the premiums.
SRMC Spring 2016
Atlanta - April 8th
61
Mutual 5
A
A
Co
K
Co
Premium-8 2/3%
each insured
L
Co
B
C
D
E
F
G
H
I
J
B
Co
C
Co
D
Co
E
Co
F
Co
G
Co
H
Co
I
Co
J
Co
Mutual 5
12 corporations insure with a mutual. A owns A Co., B owns B Co., etc. though J owns J
Co. In addition to A Co., A also owns K Co. and L Co. Each of the insureds pays 8-2/3% of
the premiums. The mutual would not meet the 20% diversity test because A Co., K Co. and
L Co. are treated as one policy holder that pays more than 20% of the total premiums.
SRMC Spring 2016
Atlanta - April 8th
62
Open Questions
 The three goals of the amendments are narrow;
they do not go into effect until 2017
 Over the next year there may be interpretations by
the IRS and people will read the statute in light of
specific fact situations
 For instance, if 20 equal insureds insure with a
commercial front, which reinsures with a group
captive, is that one policy holder or twenty 5% policy
holders
 Questions will be identified and considered over this
year
SRMC Spring 2016
Atlanta - April 8th
63
What Hasn’t Changed
 On their face, the amendments do not have
anything to do with the definition of insurance.
o If the arrangement qualified as insurance before the
amendments, it remains a good insurance
arrangement after the amendments
o The consequence of failing to meet the new tests in
2017 or beyond is that the insurance company will be
taxed under section 831(a), just like any insurance
company with more than $2.2 million of premiums
(more than $1.2 million in premiums in 2016 or
before)
SRMC Spring 2016
Atlanta - April 8th
64
Typical Structures
and
Case Studies
SRMC Spring 2016
Atlanta - April 8th
65
831(b) Captive – Definition
 831(b) is not a type of captive, but rather purely a tax election
available to certain insurers (just like a LLC could elect to be
taxed as a corporation or as a partnership)
 All types of property & casualty insurers, captive or
traditional/commercial insurers, that meet certain
requirements, could make this election
 Other descriptions used for captives that often make an
831(b) election:
o Small captive, micro-captive, mini-captive, enterprise risk captive
SRMC Spring 2016
Atlanta - April 8th
66
What works well
Common 831(b) structure
 Captive Insurer Used to Prefund Self Insured Risks (Known and
Unknown)
 No Change to Risk Profile
 Budgeting for Volatile Self Insured Risks
Common types of risks seen in 831(b) captives
 Weather risks: earthquake, windstorm, flood
 Difference in Limits / Difference in Conditions
 Property risk and related coverages (i.e. Mold)
 Cyber risk & excess liability
 Pollution liability & clean up
SRMC Spring 2016
Atlanta - April 8th
67
Common 831(b) Captive Coverage Structure
SRMC Spring 2016
Atlanta - April 8th
68
Common 831(b) Captive Coverage Structure
SRMC Spring 2016
Atlanta - April 8th
69
Case Study #1

Privately held organization – Demolition, Dismantling & Asset Recovery Organization

Complex legal structure consisting of in excess of sixteen legal entities

Performed a detailed commercial coverage and self insured claims review and identified
self insured risks that could be better managed via a captive insurer
o

Property DIC, Excess Pollution & DIC, Medical Stop Loss, Cyber Risk Liability
Company operation review also identified high severity risk exposure for which no
commercial coverage was available
o
Loss of Profit due to Safety Events

Third party actuarial review priced risks at slightly over $1 Million

Formed onshore single parent captive ($350K capital)

Captive owned by a Trust for the benefit of the Owner’s children
 May no longer qualify under new 831(b) rules
SRMC Spring 2016
Atlanta - April 8th
70
Brother-Sister Approach
Premium Payments
Parent
Sub Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
12 Subsidiaries
inferred from
Revenue Ruling
2002-90
Captive
Not Tax-Deductible
Tax-Deductible
(Note: Subsidiaries must be legal C corporations or other qualifying
“associations” but NOT disregarded entities for tax purposes)
SRMC Spring 2016
Atlanta - April 8th
71
Case Study #2

Privately held organization - Furniture manufacturer and importer

Simple legal structure consisting of only two legal entities

Client identified several self insured risk with history of manageable claims activity, but with
large claims potential. Commercial review also identified some coverage gaps that could
be better managed via formalized pre-funding of future claims
o
Business Interruption, Property Damage in Transit and Mold & Fungi, Loss of Key Employee

Third party actuarial review priced risks at roughly $900K

Formed onshore single parent captive ($250K capital)

Accessed quota share risk pool to provide risk diversification and obtain a level of risk
transfer for uninsurable risks

Captive owned by certain key employees as part of compensation/retirement plan
 Should still qualify under new 831(b) rules
SRMC Spring 2016
Atlanta - April 8th
72
Captive - Pooling
Common Mid Size Company Example
Brother-sister and third-party risk
Parent
Sub
Sub
Sub
Sub
Tax-Deductible
Premium Payments
Ceded Premium
Captive
Pool Risk
50% unrelated
risk stated as a
safe harbor
from Revenue
Ruling 2002-89
SRMC Spring 2016
Atlanta - April 8th
73
Case Study #3

Privately held organization – General Contractor

Simple legal structure consisting of only four legal entities

Client identified several self insured risks with history of manageable claims
activity, but with large claims potential. Third party actuarial review priced
risks at roughly $500k

Captive reinsured general liability risks (Not WC) from Zurich on its
Contractor Controlled Insurance Program (CCIP). Third party actuarial
review priced risks at roughly $600k

Formed onshore single parent captive ($350K capital)

Captive owned by Principal and his children (via a trust) in the same
percentage as they own the operating company
o Should still qualify under new 831(b) rules
SRMC Spring 2016
Atlanta - April 8th
74
Captive - Unrelated
Common Mid Size Company Example
Brother-sister and third-party risk
Parent
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Sub
Third Party
LLC
Tax-Deductible
Premium Payments
Captive
50% unrelated
risk stated as a
safe harbor
from Revenue
Ruling 2002-89
SRMC Spring 2016
Atlanta - April 8th
75
Questions & Answers
Patrick Theriault
Managing Director
Strategic Risk Solutions, Inc.
[email protected]
Tel: 802-861-2630
Charles (Chaz) J. Lavelle
Senior Partner
Bingham Greenebaum Doll LLP
[email protected]
Tel: 502-587-3557
SRMC Spring 2016
Atlanta - April 8th