the rise of captive insurance companies: are they … insurance.pdfcaptive tax issues (cont.) i.r.s....

The Rise of Captive Insurance Companies: Are They also an Opportunity to Address Obamacare? Moderator: Ken Levinson, Partner | Faegre Baker Daniels Jeff Brimer, COO | Alexius, LLC Kaya Bromley, General Counsel | Freedom Care Benefits

Presenters

Jeff Brimer COO Alexius, LLC (720) 360-1675 EXT 101 [email protected]

Kaya Bromley General Counsel FreedomCare Benefits (248) 302-4656 [email protected]

Ken Levinson Partner Faegre Baker Daniels +1 612 766 8341 [email protected]

What Is A “Captive” And How Does It Work?

► Captives are fully licensed, fully regulated, private insurance companies ► Domiciled (formed and regulated) in a US state (or D.C.), or foreign country ► Owned by corporation as a “parent owned” captive, or by a group or industry, to

insure specified risks ► Requires arms-length pricing on premiums paid by insureds to the captive ► Frequently will insure deductibles or uninsurable risks under commercial

programs; a cash funding arrangement to assure assets available in future to pay claims

► May use a “front,” such as utilizing the pre-existing licensing/registration of a commercial carrier (and then reinsure the specified risks into the owned captive)

► Captives can access reinsurance markets (only accessible by “insurance company”)

(c) 2015 Faegre Baker Daniels LLP. All Rights Reserved. 3

What Is A “Captive” And How Does It Work? (cont.)

►Requires capital from the owner(s) and appropriate premiums to cover risks, and provide reserves, per regulatory requirements (such as 3:1 ratio)

►Tax Benefits (non “831(b)”): can accelerate deductions for insurance reserves before claims are paid out; no state income tax on investment earnings or underwriting profits ► Tax Benefits of an 831(b) captive: smaller size insurer, premiums

paid are still tax deductible, may not receive more than $1.2MM in premiums annually, taxed only on its investment income

►Tax Costs: must pay prescribed state premium taxes (if domestic captive) ► If foreign domiciled captive, must consider application of US Subpart

F (CFC) rules and exposure to federal excise tax on premium payments (c) 2015 Faegre Baker Daniels LLP.

All Rights Reserved. 4

Business Issues Relating to Captives

► What are business objectives and expected benefits from captive? ► What insurance risks are appropriate for the captive?

► Traditional uses include highly predictable coverages/deductibles (e.g., workers comp, auto liability, general liability, etc.)

► Nontraditional, customized or volatile risks may also be written ► Strategic integration with commercial insurance program ► Continuing evaluation of potential flexible uses of captive to respond to changes in

the commercial insurance market, available lines of coverage, or exclusions ► When should the agreed risks be written by the captive?

► Apply a “crawl, walk, run” staged approach, or a more accelerated timetable based on business needs or market conditions?

► How to utilize benefits of captives? ► What kind of captive is most appropriate, and where is it to be domiciled?


Captive Tax Issues (cont.)

► I.R.S. Rulings and Structuring Considerations ► Three Revenue Rulings in late 2002 established general principles to

determine tax qualification of certain captive insurance companies ► IRS Rulings control interpretation and audit results by IRS agents ► Rulings addressed 25 years of interpretative disputes with taxpayers

► The 2002 Rulings covered three types of captives: ► Parent/Subsidiary Captives (captive insures risks of its parent and, perhaps,

unrelated risks) ► Brother/Sister Captives (captive insures risks of its commonly-owned

brother/sister affiliated companies, not its parent) ► Group Captives (captive insures specific, common risk(s) of a group of

unrelated owners)

6 (c) 2015 Faegre Baker Daniels LLP.

All Rights Reserved.

I.R.S. Rulings and Structuring Considerations

►Key common principles established in 2002 (and subsequently reinforced) by the IRS for captives to qualify for Federal tax benefits: ► All premiums must be pooled by the captive; all assets (premiums,

reserves, surplus) must be available to pay all risks being insured ► Captive cannot loan funds to its parent, owner(s) or insureds ► No parent or insured can guarantee the captive’s performance

►Additional requirements for qualification as an “insurance company”: ► Adequate risk shifting and risk distribution; requires that a loss by

one policyholder is not borne in substantial part by such insured’s premiums

► Captive must still meet business purpose, administrative/regulatory requirements, arms-length pricing, adequate capitalization, proper documentation, etc.


Example of Captive Structure


Parent Risks

Reinsurer

Possible Reinsurance / Stop Loss

Parent Corp.

Subsidiary 1 Captive

Risks from Subsidiaries

Subsidiary 2

Third Party Risks

Example of Franchise Captive Structure – Franchisor Opportunities

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Risks, Deductibles from Franchisees

Possible Reinsurance / Stop Loss

Franchisor Owner

Franchisee 1

Reinsurer

Franchisor Corp.

Owned Stores Subsidiary Captive

Franchisee 2

Franchisee 3

Franchisee 4

Parent Risks, Deductibles

Subsidiary/Stores Risks, Deductibles

Reinsurance into captive

(c) 2015 Faegre Baker Daniels LLP. All Rights Reserved.

Fronting Insurer

Some Factors in Domicile Selection

► Domestic ► Incorporated entity, formally licensed/regulated by state regulators ► If corporation-owned captive, should be included in group’s consolidated financial statements

(subject to confirmation by auditors) and Federal tax consolidated return filing ► No state income tax (on captive’s income, underwriting profits, investments, etc.), but premiums are

subject to state premium taxes ► If company were to consider in future using captive for employee benefits risks, or terrorism

coverage, must have a “domestic” captive ► Offshore

► Incorporated entity, formally licensed/regulated by foreign government regulators ► Generally not part of consolidated group for Federal tax purposes

► Not usually subject to foreign premium taxes, but other fees, licensing costs may soak up savings ► Subject to US Federal excise tax on premium payments to offshore insurer/reinsurer (4% or 1%,

respectively), unless domiciled in favorable tax treaty jurisdiction ► Likely a “Controlled Foreign Corporation” subjecting US Shareholders to current taxation

► Exception to possible CFC classification: Make a US “domestication” election


IRS Audit Activity in Captive Area

► Issues in Audit ► The arrangement doesn’t qualify as “insurance” (too few insureds,

too much concentration of risk, loan backs to parent/insureds) ► Compare the recent Tax Court decision in Rent-a-Center regarding the

“risk distribution”/concentration of risk requirements in IRS rulings… ► The captive doesn’t qualify as an “insurance company” (inadequately

capitalized, improper/unjustified premium amounts, inadequate reserving)

► State “conformity” issues (if captive doesn’t qualify Federally, what is impact for State tax purposes)?

► FIN 48/UTP reporting positions, book and tax reserve issues ► Effects of Federal tax audit adjustment on multiple years

►How to Avoid Problems With YOUR Captive? 11

(c) 2015 Faegre Baker Daniels LLP. All Rights Reserved.

$465 Billion

12 (C) Copyright 2015 FreedomCare Benefits, LLC

All Rights Reserved

►Penalty A

►Penalty B

►Catch-all Penalty


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►Penalty A - $2,084

►Penalty B - $3,126

►Catch-all Penalty ($100 Per EE Per Day) 14

(C) Copyright 2015 FreedomCare Benefits, LLC All Rights Reserved

Penalty A Example:

Scalia Construction Company has 300 Full-Time Employees. Scalia does not offer insurance. One EE receives a subsidy on the exchange. What is the penalty? $2,084 x (300 – 80*) = $485,480 * 30 in 2016


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Penalty B Example:

Roberts Dairy Farm has 2,000 Full Time Employees. Roberts offers insurance but the insurance does not provide minimum value. One thousand of Roberts’ Employees receive a subsidy on the exchange. How much is Roberts’ Penalty? $3,126 x 1,000 = $3,126,000


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Catchall Penalty Example:

C. Thomas Beverage Company has 500 Full-Time Employees. C. Thomas offers insurance but violates the 90 day rules. C. Thomas does not find out about this violation for 12 months. What is C. Thomas’ Penalty? 500 x 365 x $100 = $18,250,000


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►DOL Audit Penalties ►IRS Audits ►Lawsuits ►OSHA Whistleblower

Actions ►ERISA Violations (510)

►Costs of Compliance ►Legal / Consulting

Fees ►Audit Preparation ►Intangible Costs


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Three Steps to ACA Compliance


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Step One:

Avoid Penalty A


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Offer Minimum Essential Coverage To All Full-Time Employees and

Dependents.


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The MEC Strategy (Skinny Plans)

Limit Exposure to

Penalty A Is it legal?

Does it mean I have

no conscience?

Satisfies Individual Mandate


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Step Two:

Avoid Penalty B


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Offer Affordable Insurance that Provides Minimum Value Coverage to All Full-Time

Employees


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The Minimum Value Strategy

Walk-Away Plans

Minimum Participation

What if Too Many

Employee$ Accept it? (Pricing)

Hedging By Also Offering

MEC


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Step 3

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Document. Document. Document.


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Your Peace

Of Mind

Compliance Guarantee

Satisfy Penalty A & B

Reporting Compliance

Tax-Efficient 831(b)


FreedomCare is a Captive Insurance Company designed specifically to comply with the ACA mandates

& To deliver to employers of all sizes the benefits of self-insurance that have been enjoyed by larger companies

for decades.


The Benefits of FreedomCare FreedomCare is a South Dakota Series Business Trust licensed as a captive insurance company.

Simplified formation process • Extremely cost effective: Formation and On-going • Minimal time requirements by employer • Reinsured by Lloyd's of London

Every employer gets their own “Cell Trust” captive • Each cell is its own insurance company • No joint and several liability • No co-mingling of assets or risk pools • Potential tax benefits under IRC §831(b)


How Does The IRC §831(b) Work?

For those employers who wish to take the IRC §831(b) election, these factors need to be considered:

Note: The decision to create a captive should never be made solely on the tax benefits, and should only be made after consulting your tax advisors.

• Only applies to small P&C insurance companies with less than $1.2 million in premiums.

• If qualified, the captive company only pays tax on investment income; any underwriting income is not taxed.

• Underwriting losses are also not available, even if a loss is experienced (captive will still pay tax on investment income).


How does FreedomCare comply with the ACA?

Satisfies Penalty A By offering Minimum Essential Coverage

Satisfies Penalty B By offering a plan that provides Minimum Value


The Intent of the ACA

Every qualifying employee gets MEC Even if they opt-out of the MVP, they will have

satisfied their Individual Mandate FreedomCare differs from walk-away plans in which

lower wage workers who do not qualify for Medicaid end up with nothing. With FreedomCare, they are no longer on the hook for the Individual Mandate.

Meets the Good Corporate Citizen standard

INTERNAL REVENUE SERVICE


the rise of captive insurance companies: are they … insurance.pdfcaptive tax issues (cont.) i.r.s....

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