Captive Insurers

1
Captive Insurers

• What is a Captive Insurance Company
• Types of Captives
• Historical Development
• Reasons for Growth
• Taxation of Captives
• Captive Functions
• Risk Retention Act of 1986
• Current Issues Regarding Captives

2
What is a Captive Insurance Company?

• Established to insure the risks of the parent
  company
• A form of self-insurance
• Used by large corporations with sophisticated
  risk management programs
• Used by companies with unusual or hard to insure
  risks
• Captive insurers are alternatives to buying
  insurance from a traditional commercial insurer

3
Prime Locations for Captives

• Bermuda
• Cayman Islands
• Vermont
• Guernsey

4
Types of Captives

• Pure Captives
• Insure the risks only of its parent company and
  its affiliates
• Association Captive
• Established by a group of independent but
  similar companies to write coverage on those
  companies

5
Historical Development

• Earliest captives 1800s
• Railroads
• New England textile manufacturers (Factory
  Mutual)
• Formed to obtain coverage at reasonable prices
• Later trend 1950s
• U. S. companies transforming to multinationals
• Next expansion 1960s
• Property insurance availability problems
• Growth in 1970s and 1980s
• Medical malpractice market
• Product liability market
• Risk Retention Act of 1986

6
Reasons for Growth

• Tax benefits
• Insurance availability problems
• Reduced cost of insurance
• Improved cash flow
• Profit center
• International capital market movements

7
Taxation of Captives - 1

• Insurance companies can deduct losses when they
  occur
• Non insurance corporations can only deduct losses
  when they are paid
• Insurance premiums paid by corporations to
  commercial insurers are tax deductible
• Income earned by U.S. corporations is taxed by
  the U.S.
• Income earned by foreign corporations is taxed
  (or not) by that country

8
Taxation of Captives - 2

• Ideal tax position
• Parent company deducts premiums paid to captive
• Captive insurer deducts losses when incurred
• Parent is not taxed on income of foreign captive
  until profits repatriated (brought back to the
  U.S.)
• Unfortunately for corporations, this ideal
  position is not allowed

9
Taxation of Captives - 3

• Premiums paid to a captive are not deductible
  unless the captive is a true insurance company
• A captive is not a true insurance companies
  unless it
• Writes substantial amounts of coverage with
  unrelated entities (Sears Allstate)
• Is group owned
• Taxation of Foreign Captive Income
• Tax Reform Act of 1986
• Current taxation of income

10
Captive Functions

• Fronting Company Arrangements
• A licensed insurer writes the coverage and
  reinsures all or almost all of it with the
  captive
• Obligations of the fronting company
• Captives as Reinsures
• Parent companys risk
• Unrelated risks
• Problems of mid-1980s
• Rent-A-Captive

11
Current Issues Regarding Captives - 1

• United Parcel Service
• UPS captive, Overseas Partners Ltd, held to be a
  tax dodge
• UPS liable for 65 million in taxes for 1984
  (300 million including interest and penalties)
• Class action lawsuit for 14 billion for
  insurance fraud relating to captive
• Claims that UPS overcharged shippers for
  insurance from captive

12
Current Issues Regarding Captives - 2

• Gold Medal Insurance
• Captive of General Mills
• Refused to pay a claim for 169 million for
  pesticide contaminated grain
• General Mills sued Gold Medal
• Verdict for General Mills