1. IASA: Captive Insurance 101 VENTURE CAPTIVE MANAGEMENT Developed By
Matthew Queen, General Counsel
Phone:
VENTURE CAPTIVE MANAGEMENT
IASA:
Captive Insurance 101
venturecaptive.com

2. SUMMARY The Captive Opportunity
1. What is a captive insurance company?
2. What are the general tax considerations for a captive?
3. How do state & local taxes interplay with captives?
4. Are there any international tax issues to navigate?

3. WHAT IS CAPTIVE INSURANCE?
Captive Insurance is formalized self-insurance
Captives work best covering risks that traditional cannot or will not cover
Captives are typically C- Corporations licensed to offer insurance in a domicile that has statutory authority
Companies may join Group Captives or form their own Single Parent or “Pure” captives

4. THIRD PARTY RISKS & GROUP CAPTIVES
CAPTIVE STRUCTURES
THIRD PARTY RISKS & GROUP CAPTIVES
BROTHER/SISTER RISKS
Parent
Parent
Premiums
Captive
Captive
Subs
Subs
Third Party Premiums
From Other Employers’ Benefits Programs
Premiums
Premiums
Assume 7-12 complex subsidiaries or affiliated companies
Premiums from subs deductible
Premiums from parent non-deductible
Greatest control & flexibility
Assume affiliated group only 50% of captive’s premium
Premiums to captive deductible
Subs & parent shifted risks & premiums deductible
3rd party premiums add’l income source to captive

5. CAPTIVE EFFICIENCY How Are Insurance Dollars Spent?
Traditional Insurance
Captive Insurance
$0.40 est. Administration + Profit
$0.05 – 0.30 est. Administration Costs
$0.60 est. Allocated for Losses
$0.70 – Allocated for Losses

6. CAPTIVE IMPACT Decreased costs improve profit potential
Reduced claims improve company profit
Investment of premiums adds additional line of revenue
Absolute control over risk management program
Improved IRR for shareholders and other stakeholders

7. IDEAL CANDIDATES Sufficient organizational risk Strong cash flow
Few losses or manageable risk profile
Management multiyear commitment
Desire to create new profit center

8. FEDERAL INCOME TAX Model Assumptions:
$1.9 million in gross written premium to captive
Captive makes the 831(b) election
Small captives writing < $2.3m in GWP may elect 831(b) status and not be taxed on underwriting profit
Contrast with traditional 831(a) captives which are larger but lack the tax break
37% Federal Income Tax
$190,000 annual captive costs

10. INTERNATIONAL TAX
Barring a tax treaty, IRC imposes standard taxation on the effectively connected income of foreign-based companies. IRC § 882.
Further taxation under branch profits tax equal to 30% of dividend equivalent amount for foreign-based corp. IRC § 884.
Solution to various international tax issues: 953(d) Election
953(d) election taxes offshore captives as if a U.S. domestic company.

11. INTERNATIONAL TAX 953(d) election requires:
1) Provide the IRS an election statement;
2) Maintain a U.S. office;
3) Show ownership of assets that are physically located in U.S. with adjusted basis equal to 10% of the gross income for the base year.
Loss of 953(d) election status results in Controlled Foreign Corporation status subjects captive to 30% withholding tax on effectively connected U.S. income as well as federal insurance excise tax of premiums.

12. Welcome to the Wild West
STATE & LOCAL TAX
Welcome to the Wild West
Both the Commerce Clause and the Due Process Clause of 14th Amendment control extent to which states may tax economic activity
CC provides minimum threshold of economic activity & DP14 requires some definite intent to conduct business within a state
“Purposeful Availment”
McCarran-Ferguson gives power to states to regulate insurance
The messy legacy of Todd Shipyards
Frozen trilogy of cases from 19th century applying due process as understood in 1897 to modern cases
Huge tax savings if understood properly

13. When Does a Captive Owe State Tax?
STATE & LOCAL TAX
When Does a Captive Owe State Tax?
Assess whether Todd Shipyards protects taxpayer from remitting tax to the state
If facts very similar to TS, then take position of no tax. If differ from TS, assess Commerce Clause & Due Process of 14th Amendment
If transaction falls outside CC or DP14, then assess whether a state’s “doing business” laws govern the transaction

14. When Does a Captive Owe State Tax? Factors to Consider:
STATE & LOCAL TAX
When Does a Captive Owe State Tax? Factors to Consider:
- The insurance covers property owned by a corporation not domiciled in the taxing state;
- All of the insurers are domiciled outside of the taxing state;
- The insurance agreement is negotiated for, signed, issued, delivered, paid, and accepted outside of the taxing state;
- None of the insurers has an agent or office within the taxing state;
- No claims are invested or adjusted within the taxing state;
- None of the insurers solicit any business within the taxing state;
- None of the insurers communicate with the insured;
- All decisions regarding the purchase and renewal of insurance occur outside of the taxing state;
- All losses are paid out-of-state and all premiums are paid out-of-state.

15. IRS REQUIREMENTS
Business Purpose
Risk Shifting
Risk Distribution

16. SUMMARY
Alternative Risk Financing provides tremendous economic efficiencies
Advantages in state, federal, and international tax areas
Captives perfect solution for unique risks