B usiness owners and managers often ask themselves: what risk do I want to retain? What risk do I want to transfer? How much do I have to pay for the transfer? If they are not asking those questions, they should be. Marie has older family who fish for a living. They have owned many boats over many years and never had one sink. They have paid USD 5.6 million in insurance premiums for workers’ compensation over the past five years, while their total workers’ compensation claims over the same period were USD 1.2 million. The family has figured out the insurance company was making a boatload. This basic economic premise is driving captive insurance growth. For many years, the insurance business has been retail agent driven, whereas, the agent generates more commission by selling more commercial insurance. The new model taking hold is that insurance salespeople are replaced by true risk management consultants. It only makes sense that a company only took a USD 1,000 deductible when it had gross revenue of USD 200,000. But now revenue is USD 75,000,000, does a USD 1,000 deductible really make sense, with the knowledge you have to pay for a low deductible? Marie’s family takes risk on whether they catch fish or not. They treat their workers well and maintain a safe environment, leading to a low loss ratio. When considering a captive, the matriarch of the family said: “Are you kidding, we fish, we know risk, and sometimes we don’t catch anything.” “Why in the world would we want anything except coverage for a catastrophe?” Furthermore, they may be looking at their current risk management practices and insurance coverage noticing an increase in premiums and a decrease in coverage, but claims remaining steady year over year. Diana Hardy, CPA, CFE is a senior audit manager in the Greensboro office of Rives & Associates, LLP. Diana practices in the areas of auditing and attestation and has nine years of experience in public accounting. During her tenure she has accumulated a broad range experience in various industries including insurance, government, nonprofit entities and forensic investigations. Diana’s experience has allowed her to provide value to a broad spectrum of entities within the insurance industry including reinsurance considerations, complex and unconventional investments, complicated accounting topics, and mergers and acquisitions. Diana manages multiple captive and traditional insurance teams within Rives and Associates. Her ability to easily transition between Statutory Accounting Principles and Generally Accepted Accounting Principles and the considerations within have provided extensive value to clients. She also assists in training within the firm and holds various seminars or one-on-one training with outside organisations. Diana is a proud member of the American Institute of Certified Public Accountant, the North Carolina Association of Certified Public Accountants, and the Association of Certified Fraud Examiners. She also serves as a board member of the Goodwill Industries of Central North Carolina and a member of the Greensboro Rotary Club. Diana was recently awarded the IASA’s “Top 30 Under 30” 2018 award. Captives 101 Captive Insurance Times Domicile Guidebook Captive Insurance Times Domicile Guidebook www.captiveinsurancetimes.com www.captiveinsurancetimes.com 8 9 Captives 101 Diana Hardy Senior audit manager Rives & Associates
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Business owners and managers often ask themselves: what risk do I want to retain? What risk do I want to transfer? How much
do I have to pay for the transfer? If they are not asking those questions, they should be.
Marie has older family who fish for a living. They have owned many boats over many years and never had one sink. They have paid USD 5.6 million in insurance premiums for workers’ compensation over the past five years, while their total workers’ compensation claims over the same period were USD 1.2 million.
The family has figured out the insurance company was making a boatload. This basic economic premise is driving captive insurance growth.
For many years, the insurance business has been retail agent driven, whereas, the agent generates more commission by selling more commercial insurance.
The new model taking hold is that insurance salespeople are replaced by true risk management consultants.
It only makes sense that a company only took a USD 1,000 deductible when it had gross revenue of USD 200,000. But now revenue is USD 75,000,000, does a USD 1,000 deductible really make sense, with the knowledge you have to pay for a low deductible?
Marie’s family takes risk on whether they catch fish or not.
They treat their workers well and maintain a safe environment, leading to a low loss ratio.
When considering a captive, the matriarch of the family said: “Are you kidding, we fish, we know risk, and sometimes we don’t catch anything.”
“Why in the world would we want anything except coverage for a catastrophe?”
Furthermore, they may be looking at their current risk management practices and insurance coverage noticing an increase in premiums and a decrease in coverage, but claims remaining steady year over year.
Diana Hardy, CPA, CFE is a senior audit manager in the Greensboro office of Rives & Associates, LLP. Diana practices in the areas of auditing and attestation and has nine years of experience in public accounting. During her tenure she has accumulated a broad range experience in various industries including insurance, government, nonprofit entities and forensic investigations. Diana’s experience has allowed her to provide value to a broad spectrum of entities within the insurance industry including reinsurance considerations, complex and unconventional investments, complicated accounting topics, and mergers and acquisitions. Diana manages multiple captive and traditional insurance teams within Rives and Associates. Her ability to easily transition between Statutory Accounting Principles and Generally Accepted Accounting Principles and the considerations within have provided extensive value to clients. She also assists in training within the firm and holds various seminars or one-on-one training with outside organisations. Diana is a proud member of the American Institute of Certified Public Accountant, the North Carolina Association of Certified Public Accountants, and the Association of Certified Fraud Examiners. She also serves as a board member of the Goodwill Industries of Central North Carolina and a member of the Greensboro Rotary Club. Diana was recently awarded the IASA’s “Top 30 Under 30” 2018 award.
Captives 101
Captive Insurance Times Domicile Guidebook Captive Insurance Times Domicile Guidebookwww.captiveinsurancetimes.com www.captiveinsurancetimes.com8 9
Captives 101
Diana HardySenior audit manager
Rives & Associates
A true risk management consultant will consider whether a captive can be a solution to these questions through managing risks in a formal, measured, and tax-efficient manner.
Simply put, a captive is a privately held insurance company, which insures the risks of an affiliated business, its customers and/or others.
There are currently over 6,500 active captive insurance companies worldwide.
This is without counting incorporated and protected cells and series business units.
Many people used to think that captive insurance companies are only set up offshore. However, captive owners are bringing their companies back to the US due to convenience and the ever growing expertise of onshore service providers and insurance departments.
Not to say that offshore is bad, but there is a trend of captives returning to the US.
Choosing a domicile is important, different states/countries have different understandings of various risks being retained by a captive, and may permit accounting practices for such. When establishing a captive, it is first important to understand
the underlying business, how it operates, the particular risks related to the specific industry, or even risks that haven’t been thought about.
There are many reasons businesses are utilising captives as a risk management tool.
Captives should not be formed solely for tax purposes, but we are accountants, so we can talk about some basic tax treatment of captives.
Let’s go back to Marie’s family. Assume for a moment that the matriarch decided to forget the USD 1,000 deductible for workers’ compensation, take the risk, and increase the deductible to USD 500,000 per occurrence. Now assume that Mary Sue, slipped on a piece of rotten fish and broke her back.
It is estimated the total claim for workers’ comp will be USD 1.3 million being paid over five years.
A captive can get a tax deduction at the time of the claim (keeping in mind, this simple example is not taking into account loss discounting).
However, if a proper captive structure is not setup, an operating company may not take a tax deduction until the claim is paid. When dealing with large numbers the time value of money regarding the deduction can be a huge Bluefin tuna sold in Japan for seven figures.
TJ Strickland, CPA is a senior manager at Rives & Associates, LLP in Lexington, NC, and serves a wide variety of insurance, non-profit, and governmental clients. He specializes in the area of insurance, providing assurance, advisory, accounting, preparation of NAIC Annual and Quarterly statements, consulting, and taxation services. He services a broad spectrum of insurance entities including property and casualty mutual insurance companies, life insurance companies, reinsurers, RRGs, and captive insurance companies. Among these include companies with multi-jurisdictional requirements, multiple-lines of insurance business, reinsurance considerations, investment analysis and oversight, and mergers and acquisitions. TJ is responsible for monitoring, analysing, and commenting and internal training on developments related to the firm’s general insurance practice, including emerging regulations and rulings. He serves on a variety of boards/committees including the CICA Membership Committee, IASA Carolinas Chapter, and the NCCIA Conference Committee. TJ was recently awarded the IASA’s “Top 30 Under 30” 2018 award. When he’s not breathing and eating insurance, TJ enjoys fishing, beach time, and beer/wine tastings.
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TJ StricklandSenior managerRives & Associates
Captives 101
A few benefits to consider when establishing a captive:• Coverage availability—desired coverage
may not be available in the traditional insurance market
• Direct access to reinsurance markets—reinsurers have lower costs of operation and regulatory barriers and, therefore, can often provide coverage at a lower cost
• Ability to customise insurance programme—captives experience the freedom to insure any risk the captive chooses and to customise the terms and conditions of its policies
• Possible tax benefits—while tax benefits should not be the driving factor in forming a captive, there may be tax advantages available in certain situations
• Negotiation tool—owning a captive provides additional negotiation power during discussions with the commercial market as an insured can easily and rapidly decide to insure a risk or a portion of a risk in its captive if it is in a situation of being overcharged by the commercial market
• Capture underwriting profit—any profit from underwriting is kept by the captive company and not forfeited to a commercial insurer
You may be reading these benefits and thinking, what’s the catch?
It is expensive and just like any business decision, you must do a cost/benefit analysis.
A true risk manager should be engaging in this type of analysis.
If the anticipated benefits exceed the anticipated costs, it seems simple, but with insurance there is risk.
In order to be considered an insurance company in the view of the Internal Revenue Service, you must earn at least 50 percent of revenues from insurance activities and must demonstrate risk shifting and risk distribution (pooling of risk).
Risk shifting is viewed from the presence of the insured and occurs by the insured (the business) facing the possibility of economic loss transfers some or all of the financial consequences of the potential loss to the insurer (the captive). Risk distribution is viewed from the insurance company’s perspective.
Based on the actuarial principle of “the law of large numbers,” risk distribution entails spreading risks among a large group allowing the insurer to reduce the possibility that one claim will exceed the premiums collected. Marie’s family is good at fishing, and a business risk is whether they catch fish or not.
However, the risk that a rogue wave comes by and tosses five employees into shark infested waters resulting in multiple amputations could harm the solvency of the company.
Jennifer Cantey, CPA is an audit manager at Rives & Associates in Raleigh, NC. She has five years of experience practices audit and attestation in a wide variety of industries, including captive insurance, life insurance, and reinsurers, non-profit entities, and governments. Jennifer is responsible for developing tests on an individual audit basis, acting as a key contact between the audit team and the client, and assisting in the preparation of the financial statements. She is responsible for internal training and project management and providing assistance to clients to improve their internal controls and financial reporting functions. Jennifer is a proud member of the American Institute of Certified Public Accountant, the North Carolina Association of Certified Public Accountants, and the Washington Society of Certified Public Accountants. She enjoys kickboxing and baking, and aspires to open a rescue for abused and neglected animals.
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Jennifer CanteyAudit managerRives & Associates
Captives 101
This means insurance is needed.
When Marie’s family, or any business, considers a captive, research should include the specific domicile and type of insurance structure that is most advantageous to your specific situation.
It is important to have a team on your side to avoid errors and ensure compliance.
This team should include, at a minimum, a captive manager, certified public accountant, attorney, actuary, and a regulator contact in the domicile of your choice.
Captives are not for everyone and all domiciles are not fit for everyone. Considering of risk should be a component of any strategy meeting.
Identification of risk, assessing the risk, mitigating the risk are components of an audit (we had to throw that in since we are bean counters) but should be a component of business planning.
Alternative risk financing is a new norm for discussion.
A true risk manager will kick off the discussion, then potentially take the next step.
A formal feasibility study is typically the next step.
The feasibility study will assist in determining whether a captive makes sense, provide possible coverages for identified risks, and estimates of premiums. Captive insurance regulation is an area where you get to choose your regulator.
If you get to choose who is going to regulate you, then you should certainly investigate and have a conversation or five with potential regulators.
Once the domicile selection has been made, the formal application process may begin. At
this point, it is important to consider formation fees, premiums taxes, capital requirements, and annual financial reporting requirements in your domicile selection.
Once the captive is fully operational, it is important to discuss the role of the board of directors.
The board of directors of the captive will have ultimate responsibility and are charged with corporate governance. Boards are tasked with operational oversight, risk monitoring and risk management.
It is important to maintain open lines of communication, not only during the formation process but also once operations commence, between the board and the captive manager to ensure compliance and that the ultimate risk management goal the captive was set up to achieve is accomplished.
It is a best practice to evaluate your business on a regular basis, including business risks, current coverage, and premiums paid.
During your next evaluation, consider if a captive insurance company could be a solution to the challenges you face insuring your business.
As the captive industry grows, more professionals are becoming available that would be able to assist you in determining if a captive insurance company will work for you.
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Captives 101
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