Thought Leader – Captive Insurance
To find out about the biggest challenges that the captive insurance sector faces and the future of the industry, Finance Monthly reached out to Alan Fine – the Partner in Charge of Brown Smith Wallace’s Insurance Advisory Services practice, a subset of which is the Captive practice, which he also leads. Brown Smith Wallace is a full service public accounting firm located in St. Louis, Missouri, which serves clients throughout the US.
A large proportion of your work includes dealing with captive insurance – what would you say are the biggest challenges that the sector presents?
In my experience, the most significant challenge faced by the captive insurance sector is one of education. There are relatively few in the business world that are acquainted with, let alone understand, the purposes behind creating captive insurance companies or the risk management benefits which can be obtained through the utilization of a captive insurance company.
The education process begins with business owners and their employees. While many have heard about captive insurance companies, they tend to be familiar with the controversy issues between taxpayers with captive insurance companies and the Internal Revenue Service. As a result, assumptions are often made that the captive strategy is strictly a tax planning or avoidance device. (When structured properly there may be income tax benefits, but these assumptions ignore the fact that most captive insurance companies are established for legitimate risk management purposes rather than tax advantages). We work with our clients to educate them as to how captive insurance companies can play a role in improving the risk management function of their organizations by taking advantage of enhanced safety programs or obtaining additional coverage for potentially catastrophic exposures such as cyber liability.
In addition to helping educate the business owners, we often find that the financial institutions serving our clients do not initially understand captives, viewing the additional premiums paid solely as a drain on cash flow and income. What they ultimately realize, however, is that these companies are actually better credit risks than other debtors, since those businesses with captive insurance companies have coverage for potentially catastrophic events that other businesses do not have.
What are the benefits of forming a captive insurance company?
Most businesses, including those in the middle market space, have risks for which the large commercial insurers either do not understand, or are unwilling to provide coverage.
Many businesses have also implemented a captive insurance company as part of their strategy to address the constantly rising health care costs they encounter, as well as fund various layers of risk in potentially catastrophic areas such as cyber liability, product recall, environmental claims, employment practices issues and “wage and hour” claims filed by employees.
We also find that when businesses implement a captive insurance strategy, they realize that they have more of a vested interest in the organization’s risk management function. As a result, there is more of an emphasis on loss prevention and minimization.
Captive owners and insureds also benefit by having more control over the claims process, including the ability to self-select counsel to handle litigation arising from claims.
Looking into 2017, what do you anticipate for the captive insurance industry in the US?
2016 was a year of uncertainty in the US captive insurance industry, particularly in the micro captive segment. Captive owners struggled with determining how to address eligibility requirements made to the statute which permits micro captive insurance companies to elect to be taxed solely on investment income; In November, the IRS issued Notice 2016-66, calling for extensive disclosures to be made by these same captives, their owners, insureds and “material” advisors; and there was a great deal of confusion whether this notice made the micro captive insurance strategy a “listed transaction” for Federal income tax purposes (it absolutely did not; it provides that this transaction is one of interest for which the IRS is gathering information in order to determine how to better define and address abusive situations). This had a chilling effect on new captive formations in 2016. (Noteworthy is the IRS extension of the filing deadline from January 30, 2017 to May 1, 2017.)
There was also uncertainty resulting from the Tax Court’s extensive deliberations in the Avrahami case. (It was widely thought that the opinion would be delivered in the second quarter of 2016; that was pushed back to the end of 2017; current thinking supports the opinion release in or after the 2nd quarter of 2017.)
The industry is hopeful that some form of clarity and guidance on these issues and others will be provided this year, so that the owners and insureds of those captives set up for legitimate risk management purposes can redirect their focus to appropriate business matters.