Partnering with SIIA to Shape Captive Insurance Policy in DC

By Sandra Fenters

Over the last 5 years, we have seen a whirl wind of activity around captive insurance in Washington. Some very positive; some less so.

Consider the following:

  • Farm mutuals received a boost with the 2015 PATH (Protecting Americans from Tax Hikes) Act.
  • In the initial versions, small business captives (taking the 831b election) were originally omitted, but with some lobbying, they were ultimately included in the final bill. Consequently, these captives enjoyed a healthy increase in tax deductibility limits of insurance premiums; this was a big boost for small business captives, and it looked like the captive market for small businesses would boom.
  • The Treasury and IRS had seen abuses over the years with select captive plans and began to cast a suspicious eye on many existing captive policies. The IRS issued a series of onerous Notices (for example: 2016-66), ramped up audits and filed a number of lawsuits to target broadly any possible abuses.
  • Part of the challenge was that Congress did not specify much of the detail of the new rules which led to industry and government confusion.
  • So despite the gains for small captives in 2015, an aggressive IRS has muted much of the gains.

 

Helping to Steer the Policies

With this uncertainty, SIIA (The Self-Insured Institute of America) and its Captive Advocacy Team have been active for the last few years to help shape the legislation and policies related to small business captives utilizing the small captive tax election.

I have been active on the Captive Advocacy Team since 2015 and have made over a dozen trips to DC to support these efforts. We focus on informing the legislators about the benefits of captives and are aware of the onerous reporting requirements.

My most recent trip was this Spring when colleagues and I met with the legislative teams of Richard Burr (NC), PatToomey (PA) and David Purdue (NC). During the blitz, 13 SIIA Advocacy Team members met with 38 legislative teams.

 

SIIA Advocacy Going Forward

Ryan Work, Vice President, Government Relations of SIIA, leads this governmental advocacy program and comments that after a few years of a more reactive mindset of ‘putting out fires,’ the Team plans to be more proactive in its lobbying efforts in Washington.

My next scheduled visit is November 20, 2019.

Please let me know if you have any questions or input on this program.

Gaining Momentum: Hybrid Captives

By Sandra Fenters

Clients have traditionally looked to captive programs as a business strategy to protect their businesses by insuring property and casualty coverage gaps and/or their enterprise risks not covered in the traditional market.

Importance of Human Capital

One trend we’ve seen gaining momentum for a number of years is business owners looking to better manage the risks and costs on what many view as their ‘most important’ asset: their human capital.

These owners are asking us how they can utilize their existing captive structures to:

  • insure their employee benefits,
  • improve safety programs,
  • enhance risk management techniques, and
  • encourage behaviors to avoid certain types of risk.

For those with existing captives, particularly with property and casualty licensed captives, we are able to formally request a business plan change to add coverages, such as medical reimbursement.

‘Blend’ Captives

This is a hybrid type of program which allows the captive to issue property casualty policies, enterprise risk policies and some health care-related policies.  It is a  true blend.

What Does This Mean for Existing Captives?

There are ‘moving parts’ with all captives, but there are additional things to think about when writing coverages that involve your Company’s Human Capital, including but not limited to educating yourself on requirements of The Department of Labor and ERISA.  If you add such coverages, you may notice changes within the captive, including the following:

  • It changes balance sheets.
  • There are different requirements around reporting to regulators.
  • It alters required loss reserves.

Therefore, some caution is warranted.

But there are certainly advantages for some Companies to add coverages, such as medical reimbursement to their underwriting program, and we expect to continue to see this trend.

Questions?

If you have questions about how such a plan could benefit you, please contact us.

Capterra Risk Solutions, LLC

842 5th Avenue

Coraopolis, PA 15108

412-802-2600

information@capterrarisk.com

IRS Announces Settlement Offers for Select Captives


Update from Sandra Fenters

The IRS issued a notice earlier this week which provides a settlement offer to certain taxpayers who are currently under audit and possess bad fact patterns within their captive program.

According to DugganBertsch, the IRS has touted several recent victories with respect to “micro-captive” transactions, but these cases have illustrated bad taxpayer fact patterns that were strongly in the IRS’s favor. By litigating these bad fact pattern cases first, the IRS hopes to discourage taxpayers with stronger fact patterns from continuing their defense of their positions. However, many of the several hundred pending cases in Tax Court have more taxpayer-favorable facts and circumstances; they are likely to create a more favorable precedent.

Capterra Risk is very active on Capitol Hill, and our staff regularly conducts Congressional meetings focused on key committees of jurisdiction, including Senate Finance and House Ways and Means, as well as leadership and Chairman offices. This ongoing engagement centers around educating Members of Congress and their staff about captive insurance in general, the importance of risk mitigation and the issues facing the captive owners and managers. As part of this effort, Capterra is working to establish a set of proactive principles to help further advance and benefit the industry, in partnership with state and federal regulators.

While the recently announced settlement only applies to a small percentage of captives under current IRS examination, we wanted to make you aware of the Notice.

If you would like to discuss this news further, please contact Capterra Risk at 412.802.2600.

Captive Insurance as a Risk Management Tool

Captive Insurance in the Construction Industry

By Sandra Fenters. Originally published in Breaking Ground

Consider the following hypothetical situation: BJF Contracting was the low bid winner on a North Shore area project for the City of Pittsburgh. The project consisted of building a retaining wall to stop a steep hill from washing onto a local road. Closure of the road was necessary during construction. In order to ensure the road was reopened on schedule, the City had a $2,500 per day liquidated damage clause (LDC) in the contract.

The specifications for the concrete retaining wall called for a special type of cathodic protection to prevent rebar corrosion. There were only two suppliers of this protection system, one in Canada and one in Oregon. BJF subcontracted with the Canadian company, and included the LDC in the subcontract.

 

Failure of Subcontractor

Two months later the road was closed, the forms were ready, and the Canadian subcontractor arrived on site with the wrong type of material for the protection system. The inspector would not permit installation of anything but the specified product. Unfortunately, the Canadian subcontractor did not have the specified product in stock. To mitigate damages, BJF hired the Oregon subcontractor to complete the work. BJF had to pay an additional $4,800 to the Oregon subcontractor, 12 days of liquidated damages, as well as other jobsite costs incurred during the delay.

BJF is out $54,000 and files suit against the Canadian company for breach of contract. The court ruled that the LDC was in fact a penalty clause and unenforceable, since the subcontract value with the Canadian company was only worth $13,000. The only damage BJF could collect was the $4,800 for their reliance interest.

Unfortunately, this is not an uncommon occurrence in the day to day life of a contractor. Unforeseen exposures rear their ugly head on job sites every day which is why managing and mitigating risk factors, including safety issues, is so critical to the health of a contractor’s balance sheet.

What are your everyday risks?

Have you ever taken an inventory of the risks you inherently absorb in your business everyday as a contractor? Some of the risks you already mitigate by way of paying premiums to the traditional insurance marketplace include workers compensation, auto liability, and general liability.

But what about the risks you assume every day in contracting that are not insured by the traditional marketplace? Possibly risks such as job-site pollution, extensive punch lists, subcontractor disputes, engineering defects and unforeseen conditions the owner will not recognize, and liquidated damages as seen with BJF Contracting? These hazards are often the events directly affecting the profit margin on a project versus a well-thought out estimate. The estimators probably calculate some of the costs associated with these unforeseeable challenges, but if weighted too much in the estimate, you lose the bid.

What could they have done to help prevent or offset the liquidated damages with the City? Typically it is the operational managers of a construction company who try preventing the type of loss incurred by BJF Contracting. While the operational staff works to mitigate these risks, the CEO or CFO can also work to protect the company from these unexpected losses, beyond the utilization of the traditional insurance marketplace.

Challenges of Construction industry

The construction field is an industry class that has historically been rated by the traditional insurance market as “high risk.” The demand for the use of alternative risk finance mechanisms, known as captives*, by contractors began to increase with the advent of the hard insurance market cycle in the early 2000’s. As the soft market quickly dissipated during this time, traditional carriers were restricting coverage and increasing rates industry-wide. The result was the best-in-class companies began subsidizing the worst-in-class, forcing contractors to seek alternative forms of procuring insurance. Today a majority of mid-to-large size contractors are participating as members of a group captive arrangement, either homogeneous (i.e. National Roofers Association) or heterogeneous (multiple trades) in nature.

Joining a group insurance arrangement with like-minded companies is not uncommon in the construction industry. If structured properly, these group captives can provide protection for traditional statutory coverage such as workers compensation and auto liability, and at the same time return investment income and an underwriting profit as a result of good loss experience to the members of the group. While group captives harness these important aforementioned benefits for its members, they are an extension of the traditional market place, not a replacement thereof. In other words, in a group captive environment, coverage may not have been afforded for the loss experienced by BJF Contracting.

In addition to group captives, there are many types of captive arrangements available to assist contractors with strategic planning and if your trusted advisors are not talking to you about these, they should be. Specifically, have you ever entertained the idea of owning your very own insurance company?

Are captives available for smaller companies?

It is often a misconception that owning your own insurance company, referred to as a pure single parent captive, is an option not afforded the closely held businesses and their respective owners. While it was once believed that only the publicly traded companies and large well-capitalized private companies could take advantage of the numerous benefits afforded by owning your own insurance company, it is no longer the case.

Actively participating in a group captive arrangement does not preclude a business and its owner from creating its own separate profit center by way of a single parent captive that would underwrite the risks endemic to the construction industry that are inherently and historically self-insured by the owner. By converting the characteristics of a self-insured arrangement (i.e. liquidated damages) to a captive insurance company arrangement, the business may be able to accelerate the deductions of the premiums as an insurance expense to the operating company and the captive may be able to build up reserves and policy holder surplus in a tax advantageous manner.

Harnessing all of the benefits of owning your own captive insurance company, including the tax benefits, is simply prudent strategic planning. As long as the proverbial tail (tax) is not wagging the dog (insurance and business purpose), you should have a solid foundation for your captive to build upon. “Tax litigation has taught that a captive, in order to justify its tax benefits, must demonstrate economic substance and business purpose independent of such tax benefits. This does not mean that a captive cannot openly pursue the tax advantages that ensue from qualifying as an insurance company. Instead it means that the simple pursuit of federal tax advantages is not enough to sustain the decision to create a captive.” [1]

What if BJF Contracting had implemented its own single parent captive? First, the contractor would have paid premiums over the course of the year, creating a deductible expense for the contractor in year one and all subsequent annual renewals. Those premiums would have then accrued within the captive, earning investing income, free from third party creditors and liability. At the time of a claim, BJF Contracting would seek reimbursement from its captive for the total loss amount of $54,000 plus legal fees.

In the absence of the captive, BJF incurs those expenses within the contracting business however, the deduction is not allowable until the amount is actually paid, referred to as an “economic performance,” which might not occur until future accounting and/or tax periods. By implementing a captive the contractor smoothes out the affects of losses on cashflow, builds up reserves to be utilized for potential future claim activity that may be excluded by other sources of insurance, builds up surplus to be utilized to negotiate with bankers or sureties, and may also experience certain tax and asset protection advantages as well.

Closely held contractors, such as BJF Contracting, owning closely held captives, may be a perfect match for weathering through the soft and hard markets of both the construction and insurance industries.

* The term “captive” comes from Frederic M. Reiss, who coined the term while he was bringing his concept into practice for an industrial client in Ohio in the 1950’s, Youngstown Sheet & Tube Company. They had a series of mines where the ore was used solely for the company’s operation and its management referred to them as captive mines. When Reiss helped the company incorporate its own insurance subsidiaries, they were referred to as captive insurance companies because they wrote insurance exclusively for the captive mines. Reiss continued to use the term for his concept and both the captive and the term have adopted a far wider context.

[1] November 2008 Captive Review “When the tail wags the dog” Randy Beckie and Phil England of Anderson Kill & Olick.

Sandra Fenters is President of Capterra Risk Solutons, an insurance and risk management brokerage firm located in Pittsburgh.

Captive Insurance as a Risk Management Tool

Breaking Ground

The Big Picture

November/December 2011

Captive Insurance as a Risk Management Tool

By Sandra L. Fenters

Have you ever taken an inventory of the risks you inherently absorb in your business everyday? Some of the risks you already mitigate by way of paying premiums to the traditional insurance marketplace include workers compensation, auto liability, and general liability.

But what about the risks you assume every day that are not insured by the traditional marketplace? Possibly risks such as job-site pollution, extensive punch lists, subcontractor disputes, engineering defects and unforeseen conditions the owner will not recognize, and liquidated damages….

To read the full article, please click on: BreakingGround Captive Article Nov-Dec 2011