State of the Captive Insurance World
2014
SRMC Presentation
Somers Risk Consulting
October 23, 2014
Prepared by:
Kathryn Marsh
Somers Risk Consulting
[email protected]
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• 831(b) mechanics
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• What we are Seeing in the Captive World
• Micro-Captive Update
• Pooling Arrangement Example
• Recent Case Studies
• Appendix
2014
Index
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What we are seeing
• Continued interest in captives – both large and small
•
Insurance community continues to recommend
•
Accountants, lawyers and financial consultants learning and
• More creative uses of captives as owners recognize additional
2014
recommending more.
• Domiciles continue to compete and become increasingly
business friendly. New entrants vying for business.
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revenue potential and/or risk management potential
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Micro-Captive /831(b) Company Option
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• Potential to insure and pre-fund enterprise risks in a highly tax
efficient manner. These risks have typically been self-insured
with no proactive approach to mitigation.
• Potential to share risk and decrease exposure to catastrophic or
large losses
• Asset protection
• Favorable tax treatment
• Estate planning/wealth transfer
• Me too factor!
2014
• Ever increasing interest and growth in this sector –
primarily due to the recognition of the following benefits:
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IRS Position
•IRS continues its of scrutiny of 831(b) captives through a review of the
more aggressive pooling arrangements.
•Many were openly developed as tax shelters:
•No documentation
•Circular flow of cash – money paid into captive, loaned back out, etc.
• Captive funds were used to buy life insurance
• Well constructed, more conservative programs are not being reviewed.
• Message – Microcaptives are a very legitimate risk management
tool and can have significant positive tax advantages – but they
must be formed for the right reasons and have operations
consistent with traditional insurance companies.
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•No proper process for pricing risk – or excessive pricing
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•No business purpose
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Sample 831(b) Pooling Arrangement
• Typically about 50% of the captive’s total premium is ceded to the pool
and a similar premium is retroceded back to the captive.
• The retroceded premium is a mix of premium from all participants. It is
unrelated, third party business and, as such, qualifies the captive as a
bona fide insurance company. Insurance companies qualify for favorable
tax treatment.
• Simple excess of loss structure with relatively small excess layer ceded to
the pool ($210K xs $15K).
• Participants share risk within layer on quota share basis.
• Provides reinsurance protection for captives against mid-size claims.
• Substantially reduces volatility in captives’ underwriting results.
• Excellent risk distribution.
• Pool protected by aggregate reinsurance from third party reinsurer.
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A reinsurance pool that allows participating captive insurance
companies to pool risk among themselves.
Pool Details
• Reinsurance protection. Losses between 0.625% and 3% of
total pool premium are paid by the reinsurer. (Currently
translates into losses of between about $187.5K and $900K).
• Participants expect to pay some level of claims each year.
Historical results range from years when no losses to losses
of $300 + per $100,000 in premium.
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• About 65 participants with total pool premium of
approximately $30 million.
Top 10 Pool Coverages
1. Reputational damage
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2. Express and implied warranty
3. Loss of key customer
4. Loss of key employee
5. Administrative actions
6. Contingent business interruption/loss of revenue/work stoppage
7. Computer data restoration/cyber
8. Wrongful acts
9. Loss of key supplier
10.Work stoppage
Premiums are currently determined by five different actuarial firms.
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Program – Risk Exchange Example
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Program Structure
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Structure Overview
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2014
Case Studies
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Case Study 1
• Solution:
• Develop a fronted arrangement with an A-rated carrier to provide a similar insurance
policy.
• Establish a captive to 100% reinsure the fronting company.
• Result is more control over the coverage provided and pricing.
• Large revenue source versus a previous costly expense area (cost of monitoring security
deposit escrow funds, litigation). More than double the revenue they obtain from the
agency program.
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• Facts:
• Property manager client - managing about 100K units.
• For some properties, they have offered the property owner an alternative to the collection
of security deposits. They offer an insurance alternative which covers the risk of damage
to property and loss of rents in the case a tenant breaks a lease. The property owner
increases the monthly rent to cover the premium payment - usually by 1-2% of the rental
amount.
• The property manager has established an insurance agency which pays commission of
about 15% on these policies.
• Loss ratios to date are in the range of 25%.
2014
Client – Property Manager
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Case Study 2
Client – Entertainment company
• Facts:
• TV Production company with many uninsured risks related to production.
• Solution:
• Establishing a captive which makes the 831(b) election to obtain the tax efficiencies.
• Will cover the risks including: Administrative action, regulatory change, legal expense,
contingent business interruption, cyber liability including data restoration, exclusion
buyback and excess on P/C policies, intellectual property, work stoppage, reputational
damage, and a few others.
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2014
• Would like protection but, if coverage is even available, does want the coverage at price
charged by specialty markets
• Using a pooling arrangement to share the risk and purchase reinsurance protection.
• Client obtains coverage for risks otherwise self-insured at very reasonable price and in a
very tax efficient manner.
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Case Study 3
Client – Staffing Company
• Facts:
• Staffing company having issues with obtaining WC coverage.
• Has cash flow and wishes to increase deductibles and retain more risk but current carrier is
not allowing and at same time is threatening cancellation.
• Will establish a captive to insure the deductible layer as well as other self-insured risks.
• Will use a pool to share the non-WC risks (the pool doesn’t want to cover the WC risks).
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• We believe we have found a specialty front company that will write the risk on a high
deductible basis.
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• Solution:
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Contact: Kathryn Marsh
Somers Risk Consulting
[email protected]
770-645-2242 (o)
770-286-7551 (c)
2014
For more information….
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Kathryn Marsh, Managing Director
Somers Risk Consulting
Kathryn has a Bachelor of Business Administration degree majoring in Insurance from St. John’s
University in New York and an MBA with a double major in Finance and Multinational Management
from the Wharton School of the University of Pennsylvania. She holds the Chartered Property and
Casualty Underwriter (CPCU) and Associate in Risk Management (ARM) designations.
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Prior to establishing Somers Risk Consulting, Kathryn held high level consulting positions with
boutique captive consulting firms as well as large firms such as KPMG and AON. At AON she headed
the company’s regional quantitative and alternative risk groups, and was Chair of the company’s
Captive Council, a network of the key captive personnel worldwide. Her employment at KPMG was
within the Structured Risk Financing Group of KPMG’s Tax Practice where she was fully immersed in
captive tax strategy. Kathryn also spent a number of years managing captive insurance companies in
Bermuda with Marsh and was the Director of Risk Management for NCR Corporation. Most recently
she was the insurance expert within the management team of a cell phone insurance company where
she structured and implemented the risk program which helped grow the entrepreneurial company
into one that was recently acquired by Brightstar, a $5 billion global distributor of mobile
communication equipment.
2014
Kathryn Marsh is a seasoned consultant within the alternative risk industry with over 30 years of
experience in various facets of the industry. After many years of working for various large and small
companies, she has formed Somers Risk Consulting which specializes in captive and alternative risk
consulting and captive management.
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2014
Appendix
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• Section 831(b) of the IRS Code
allows Property/Casualty insurance
companies writing under $1.2
million in premium to be taxed on
investment income only. They are
not taxed on underwriting income.
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What is a Micro-Captive?
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• Premium payments from company to insurance
company are a tax-deductible expense
• Premium less losses/expenses = underwriting profits.
Underwriting profits grow in captive untaxed.
• Annual – therefore, ability to have significant tax-free
growth
• Typically, tax will be paid on dividends when paid typically at dividend/capital gains rates – currently 20%
for top tax rate payers.
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How does it work?
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An Example
Financials Assuming No Losses – Single Year
Insured Company’s financials:
Premium payment
Tax Deduction
After tax cost
$1,000,000
400,000
$600,000
Net Cost = $600,000
$1,000,000
70,000
-0930,000
-0$930,000
Net Value = $930,000
Annual Benefit = $330,000*
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (will be subject to taxation – typically federal only, not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet
risk management needs.
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Premium income
Captive Admin Expenses
Losses
Underwriting Income
Tax due
After tax Retained Earnings
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Captive Insurance Company financials:
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An Example
Financials Assuming No Losses – After 5 Years
Insured Company’s financials:
Premium payment
Tax Deduction
After tax cost
$5,000,000
2,000,000
$3,000,000
Net Cost = $3,000,000
$5,000,000
350,000
-0$4,650,000
-0$4,650,000
Net Value = $4,650,000
Five Year Benefit = $1,650,000
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (but will be subject to taxation – typically federal only/not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet
risk management needs.
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Premium income
Captive Admin Expenses
Losses
Underwriting Income
Tax due
After tax Retained Earnings
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Captive Insurance Company financials:
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An Example –
Estate Planning Vehicle
With Captives owned by One Heir – After 5 years
Insured Company’s financials:
Net Cost = $3,000,000
$ 5,000,000
Unknown but tax rates have been as high as 55-60% in past
$ 2,000,000
Total of Financials of Captive Insurance Companies owned by 3 Heirs :
Premium income
Captive Admin Expenses
350,000
Losses
Underwriting Income
$ 4,650,000
Tax due
After tax Retained Earnings
$ 5,000,000
-0-
Net Value = $4,650,000
-0$ 4,650,000
Five Year Benefit =
$2,000,000 + $1,650,000= $3,650,000
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (will be subject to taxation - typically federal only/not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet risk
management needs.
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Reduction in Value of Estate
Reduction in Estate Taxes
Assume 2013 40% Rate
$ 5,000,000
2,000,000
$3,000,000
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Premium payment
Tax Deduction
After tax cost
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