In Memoriam: Saying Goodbye to Unethical Captive Insurance Planning

By now, you’ve probably heard about the IRS’s list of so-called “abusive tax structures” or alternatively, the “dirty dozen.” Each year, the Internal Revenue Service puts America on notice, warning corporate moguls and freelance part-timers alike to steer clear of unlawful schemes that might allow them to skate by on their taxes. It is a commendable strategy to keep everyone focused on the collective task at hand: to contribute to society and foster its ongoing social and fiscal health.

This year’s list included a corporate alternative risk management strategy that was in fact enacted by Congress—the utilization of captive insurance companies under IRC Section 831(b).  As a result, uncertainty took root among financial advisors and prospective captive owners, sparking discussions on the questionable practices of some captive managers in the industry and the fundamental reasons why anyone would choose to form a captive in the first place.

In recent weeks, Capstone and The Feldman Law Firm LLP have fielded questions regarding the “dirty dozen” list and the reason why captives (as lawful insurance structures) were included. Capstone and the Firm also received questions on the effectiveness of a true turnkey approach to captive planning, i.e. providing clients with an all-in-one solution to the formation and continued management of their captive insurance companies. What are the advantages of having all major captive services under one roof? Why would the Service include captives if small insurers are included in the tax code?

The short answer is that there have been some bad players in the captive insurance arena, casting a shadow on both the industry, and the more conservative captive management companies that adhere to regulatory guidelines and U.S. federal tax law. These particular “captive managers” have provided only a baseline level of service, doing the clerical and administrative work needed for the initial setup of a captive. But what of the feasibility studies by certified insurance professionals to gauge the level of risk inside a business? What about the actuaries, tax and corporate lawyers, financial professionals whose services can be leveraged to ensure good legal standing over time? In the conventional sense, these services haven’t been traditionally provided by one company but rather outsourced, or omitted altogether.  The necessity of providing the critical services to keep captive owners compliant is a song long sung by Capstone and the Firm. Essentially, we believe it is time for the industry to pay its respects and say goodbye to the arguably narrow and unethical captive planning practices of the past—the same unethical practices called out by the Service.

In this article, we’ll give you the facts on the current state of captive insurance. We’ll also give shed light on the powerful benefits afforded to midmarket businesses that are insured with tailor-made coverages under a captive.

RIP to Captive Insurance Concerns

Not long after the flurry of press releases covering the “dirty dozen” list filled our inboxes, we saw many captive managers show their best efforts to enact damage control and ease captive owners’ fears. It’s true that apprehensiveness to form a captive can be pinpointed to the IRS’s firm warnings on illegal tax practices—but there’s more to the story. The uncertainty surrounding new captive formations could actually limit business owners’ ability to fully protect their organizations from potential risks. Fear of an audit can stifle the powerful business planning benefits of a captive, not seen with other structures, including 401ks, mutual funds, and mortgage-backed securities.  The irony here is that many captive managers and even some financial institutions cannot fully support captive owners in the tax and legal aspects of compliance. In this regard, the apprehensions are warranted. Although the Service released a statement in February 2015 stating that fewer audits would be conducted due to budget cuts, individuals’ whose captives were not set up properly could still be at risk for scrutiny. Additionally, the absence of essential legal backing could leave many captive insurers on their own in tax court. This is why true turnkey captive planning is essential; insurance, tax, actuarial, and legal expertise is needed to properly form and maintain a captive as they are highly regulated by the domiciles that they are formed in and by the U.S. government.

Captive Insurance Planning Bottom line: there are many moving parts that can and should be handled by experienced, licensed professionals. If a captive insurer has leveraged the expertise of a turnkey captive planning firm, they have the opportunity to utilize the captive for not only a vehicle for insurance, but for corporate planning. As long as a business owner’s captive planning firm can offer this expertise and ongoing support, their fears about non-compliance should be left at bay.

For midmarket businesses, there are powerful benefits to forming a captive insurance company to insure risks. Case-in-point, they allow for business owners to take out secured loans--funds to be used for investment purposes, equipment, work spaces, and a host of other needs. Premiums paid to the captive under IRC 831(b) are tax-deductible, and operating business owners can opt to have a junior generation have ownership of the captive, creating an estate planning benefit. Asset protection by way of a captive is also a huge incentive for business owners.  All monies paid by the operating business to the captive reduce the assets of the operating business by the same dollar figure.

Business owners and advisors who are on the fence about captive insurance should be aware that the Service has put a spotlight on those individuals and companies that have bent the rules, gone rogue, and touted weak reasoning for disclaiming tax and legal services in the formation and management of a captive.

Capstone and The Feldman Law firm empower prospective clients to cover risks while leveraging legal representation, insurance, tax, and actuarial services that are offered for one turnkey fee. For captive owners who have already instituted a captive by a different captive manager or planning company, the Firm offers a comprehensive evaluation of their existing program by way of its “Captive Health Checkup.” Corporate and tax attorneys review the legal and regulatory standings of the captive and objectively determine its standing. The Feldman Law Firm LLP was the first to implement such a program, as it was determined early on that compliance was paramount to the overall success of both the operating company and its associated captive.

Overall, captive insurance continues to serve as a powerful insurance vehicle, covering those in manufacturing, transportation, oil and gas, healthcare, and other high-risk industries. The industry continues to grow exponentially, as the availability of captive programs to midmarket companies by way of the IRC 831(b) election becomes more widespread. Captive domiciles, or jurisdictions, are springing up across the United States in order to accommodate growing demand.

Remaining compliant with tax laws and regulatory guidelines is essential—the “dirty dozen” echoes this sentiment and stands as a reminder that unethical practices in the captive arena will not be tolerated. It is integral for existing and prospective captive insurers to fully vet their captive managers and ensure that they are getting all of the services needed to keep them in good standing.

To learn more about Capstone’s captive insurance and alternative risk planning services, or about The Feldman Law Firm’s “Captive Health Checkup,” please fill out the form on the top right or give us a call at WEB_TEL.