By Craig Adoor
The following is Part VI of a six-part series of blog
postings regarding whether a captive insurance subsidiary or one owned by the
owners or affiliates of a company may represent an effective risk management
tool that also provides economic benefits.
Although there are various types of
captive insurance, this posting will focus primarily on single parent/pure
captives and how they might provide economic benefits for you or your
healthcare company.
Part I, Part II, Part III, Part IV and Part V of the blog series are here. This
posting provides an overview of certain other considerations to forming a
single parent or pure captive.
Part VI – Costs, Expenses and Other
Considerations in Forming a Captive
As any experienced business owner, executive or manager understands, risks,
costs and expenses are associated with almost every business opportunity. The
opportunities and benefits that may be realized through a single parent captive
subsidiary are no different; they, too, are subject to costs and expenses.
Costs to Organize and Qualify the Single Parent
Captive with the Appropriate Jurisdiction
Apart from the time spent in the initial consideration regarding whether
organizing, implementing and operating a captive insurance subsidiary makes
sense from a business perspective, once the decision is made to move forward,
the company will incur costs, expenses and professional fees. These costs and
expenses will include but will not be limited to:
professional fees for preparing the feasibility study;
fees of the actuary to prepare the report required by the feasibility
study;
preparation of the documents other than the feasibility study that must be
submitted as part of the application to the selected jurisdiction’s captive
insurance division; and
accounting and legal fees.
Thereafter, unless the parent has experienced insurance executives and
staff who can operate the captive, it will incur additional costs and expenses
as it pays a “captive manager” to operate and manage the captive insurance
subsidiary, prepare the financial statements and make the required annual
filings and other filings with the applicable jurisdiction’s insurance
regulatory authorities. The parent will also need tax professionals,
accounting and some legal assistance to handle issues as they arise.
Although some of the costs, expenses and fees are “one-time only,” and the
ongoing ones are not necessarily prohibitive, they must be weighed against the
overall insurance benefits, economic savings and profit and earnings potential
and other benefits to be garnered by the parent from having a single parent
captive insurance company in place.
Costs, expenses and professional fees
cannot be estimated for the purposes of this posting because of the many and
varied factors that drive them, the characteristics of the subsidiaries that
will be insured and the industries in which they operate and the experience,
quality, skills and fee structures of the professional service firms providing
assistance.
Captive Insurance Companies are Regulated Entities
that Limit the Abilities of their Parents or Owners to Operate them
Freely
As is any insurance company offering the types of insurance that may
lawfully be offered by a captive insurance company, captives are regulated
entities – regulated by the insurance department or division of the government
under which the single parent captive is incorporated, organized and licensed.
The role of the insurance regulators is to protect insureds – those persons or
entities paying premiums to the insurance company for liability protection.
Initial and On-going Regulatory Capital Requirements
Among the chief concerns of insurance regulators is to make certain an
insurance company has mandated minimum statutory capital sufficient to pay a
portion of the insurance claims that may be submitted to the company by or on
behalf of its insureds.
Most states’ statutory mandated initial capital
requirements are between $250,000 and $300,000 and of course increase based on
the amounts and type of insurance coverage offered to the brother-sister
affiliates. Over time, as more types of insurance are offered, as the amount of
coverage increases and as the number of insureds increase, the capital
requirements increase as well. Of course, as previously noted, profits and
earnings of the captive and its earnings on investments can be retained as
capital but capital requirements remain a necessary and potentially expensive
consideration.
Those considering organizing and operating a captive should realize and
factor in to any analysis the fact that money contributed to the captive
subsidiary as regulatory capital is not easily freed up while the captive has
insurance policies in place.
It should be noted that off-shore jurisdictions that have captive insurance
statutes, laws or regulations may have different capital requirements than
jurisdictions in the United States. This blog posting is limited to
jurisdictions in the United States that have captive insurance statutes.
Restrictions on Investments
In some jurisdictions in order to certify availability of liquidity, the
insurance regulatory authority may prohibit investment in anything other than
low-risk, low-return funds.
Alternative Uses of Funds Used as Regulatory Capital
Rather than being tied up in the captive insurance subsidiary as regulatory
capital, the parent could instead use those funds for other corporate
purposes including capital expenditures and corporate acquisitions for its
operating subsidiaries.
Dividend and Other Restrictions Imposed on Captive
Insurance Subsidiaries
The statutes and regulations of the various jurisdictions also regulate the
payment of dividends and distributions to the owners of the captives and they
also regulate mergers and asset sales by insurance companies, including captive
insurance companies.
As a result, boards of captive insurance companies must
seek approval from state insurance regulators before dividends and
distributions may be made by the captive subsidiary to its parent or owners,
and the parents and owners are restricted in connection with the sale of, or
corporate changes regarding, the captive.
In other words, unlike other
unregulated subsidiaries a parent may operate in which dividend payments and
distributions from profits and retained earnings are virtually unregulated,
payments from a captive to its parent or other owners may not flow freely and
are restricted to prior approval by the applicable state insurance regulators.
Conclusion of Six-Part Series
Single parent captive insurance is a risk management tool that when used
primarily to address a company’s liability insurance needs has a number of
ancillary but economically beneficial aspects, particularly in the areas of
cost containment and even profitability for its corporate parent. It can
provide tax advantages for all companies and particularly important tax
benefits for smaller companies that can take advantage of the 831(b) election.
However, costs and expenses of implementing and operating a captive insurance
subsidiary must be factored in.
The starting point for any analysis is whether the company has valid and
bona fide insurance needs and economic and business reasons for forming the
captive insurance company. Without those, the company will not pass
potential IRS scrutiny and it will not enjoy the benefits and advantages
captive insurance can provide. Worse yet, the insureds could lose the
deductions they took and the captive insurance company could be required to
recognize the premium payments it received as income.
The company should also
consider its own financial position, the cost it is paying for insurance
coverage, whether it is covering the real liability risks the company faces and
whether the potential benefits of implementing a captive insurance subsidiary
and operating it annually are worth the costs and expenses.
We suggest that in conducting the analysis, management consult with
insurance and actuarial professionals, tax accountants and corporate attorneys
who are experienced with captive insurance.
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