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

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

Prime Locations for Captives Bermuda Cayman Islands Vermont Guernsey

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

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

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

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

Taxation of Captives - 2 Ideal tax position: 1.Parent company deducts premiums paid to captive 2.Captive insurer deducts losses when incurred 3.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

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

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 company’s risk Unrelated risks Problems of mid-1980s Rent-A-Captive

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

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