Alan Fine is a tax partner at Brown Smith Wallace, leader of the firm’s Captive Insurance Advisory Services Practice and President of the Missouri Captive Insurance Association. Brown Smith Wallace is a full service public accounting firm based in St. Louis, Missouri with over 280 employees, which serves clients throughout the United States. Here Alan talks to Finance Monthly about the legislation surrounding captive insurance in the US, as well as the advantages and challenges of the captive concept.
As a nationally recognised specialist within the captive insurance industry, what is the legislation surrounding captive insurance in the US? In your opinion, how robust is the current regulatory regime in regards to the sector?
When discussing the regulatory environment of captives in the United States, it is important to recognize that there are two aspects to consider: that of the domiciles and the Federal income tax environment. Both regimes have different but equal opportunities to impact how captives are run.
The number of states with captive enabling legislation has increased dramatically over the past decade. At this point, over 35 states have some form of statutory framework enabling captive insurance company. This proliferation of domestic domiciles has been accompanied by increasing sophistication in terms of the legal structures offered by the states with which to form captives. Onshore domiciles offer similarity flexibility in structures as exist offshore. As is the case offshore, the regulators in the domiciles generally have spent their careers in the insurance/captive industries and thus, have a deep understanding of not only the legal issues but also the risk management issues potential and current captive owners are faced with.
Captive has been an attractive alternative to self-insurance in the past few decades – in what circumstances is it favourable to establish a captive insurance company?
Captives are most attractive when a business is faced with the issue of being unable to obtain any or adequate coverage in the commercial marketplace for risks which could potentially cripple a business. The most obvious example, particularly in the middle market space, is cyber liability. Most businesses are able to obtain some level of coverage for these risks in the commercial marketplace but the coverage tends to be inadequate compared to the costs a business faces when dealing with this issue. Captives provide an alternate risk financing vehicle for these businesses to address this very significant issue. Creating a captive can also be beneficial for those businesses with better than average risk profiles, which the commercial marketplace tends to ignore when pricing premiums.
What would you say are the particular advantages of the captive concept for companies when managing their insurance risks?
The most significant advantage of a captive is the ability to obtain coverage for risks not covered at all or appropriately by the commercial marketplace, effectively building up funds to address risks which could be catastrophic to a business. A captive also provides the opportunity for a business to tailor coverages to meet the specific needs of the insureds as well as have more control over the claims processes.
What are the key considerations for companies looking to enter the captive insurance space? What are the particular challenges faced by companies who wish to pursue this way for their captive needs?
When contemplating the implementation of a captive insurance strategy, the most important consideration is what risks to insure in the captive. A captive needs to insure real insurance risks in order for the arrangement to be sustained in the event of an examination by the Internal Revenue Service. It is also important to adequately capitalize the captive and appropriately price the premiums in order to ensure that the captive will be able to pay the claims as they come due. An actuarial certification of the premium pricing is also critical. The structure of the overall arrangement should also be reviewed with a qualified CPA or tax attorney in order to ensure recognition as an insurance company for Federal income tax purposes (without which the premiums paid to the captive will not be deductible). Some of the challenges our clients have encountered include deciding which coverages to insure in the captive, limiting premiums to the cap provided for small insurance companies under the Internal Revenue Code, and helping readers of their financial statements understand the captive insurance concept.