It’s always nice to find yourself in good company, and this is certainly the case for CIC Services, LLC in the captive insurance industry. A recent article published in ESTATES & TRUSTS written by Attorney Celia Clark thoroughly confirms our approach to captive insurance strategies and management. Without a doubt, Attorney Celia Clark in New York is one of the top captive attorneys in the U.S. Her June 24, 2014 article is titled. “Thinking About A Captive Insurance Company For Your Business?” Importantly, she notes that, “The two most common business reasons for the formation of small CICs are the: (1) capturing of profits from low risk exposures, and (2) coverage of uninsured or underinsured losses.” To read the entire article, CLICK HERE.
As a first order of business, the article emphasizes that accessibility to captive ownership for small family-owned businesses has blossomed in recent years. Celia points out, “More recently, family businesses and closely held businesses have been able to enjoy these same benefits of CICs.” She goes on to say, “Previously, it wasn’t cost-effective for a small business to form one…[a]s more U.S. states and foreign jurisdictions enact CIC legislation, however, the forces of competition have resulted in lower costs for CIC formation and operation.” We have recognized the same trend and opportunity for small and mid-size business owners. To read our recent article on competition among domiciles making captive more accessible to smaller businesses, CLICK HERE.
In addition to their primary function as a risk management tool, captive insurance companies can also serve as powerful financial vehicles. The article addresses the tax advantageous treatment that captive insurance companies receive. Specifically, “Internal Revenue Code Section 831(b) has included a significant income tax benefit for small insurance companies since 1986…[u]nder this section, eligible companies are taxed only on investment income.” To read one of our prior discussions on the tax-favored treatment of captive insurance companies and the role they can play in wealth accumulation, CLICK HERE.
Among the many risks facing small business owners, one of the most daunting is the risk of a lawsuit or other creditor wiping out their business and erasing their hard-earned wealth. According to Celia, one of the many benefits of a captive insurance company is the asset protection that it affords. She writes, “they provide important asset protection benefits, because an insurance company’s assets by statute are exclusively reserved to policyholders and aren’t accessible to creditors of either the business owners or the CIC owners.” We have thoroughly discussed this benefit on our web site. To read more CLICK HERE.
Another threat facing small and mid-size business owners and their families is the potential loss of the business caused by the “death tax.” It is not uncommon for families to sell-off businesses and assets to pay the “death tax.” The article proposes a potential solution by outlining potential estate planning and tax efficient wealth transfer benefits of captive ownership. She writes, “Estate-planning benefits may also be available if business owners’ family members, or trusts for their benefit, own the CIC.” Our web site thoroughly discusses this ancillary benefit that captive insurance companies can afford business owners and families. To read more CLICK HERE.
An additional ancillary benefit of owning a captive insurance company is the ability to utilize it as part of a deferred comp program for key employees. Clark notes, “key employees may be issued shares in a CIC, to vest over a period of time, as an incentive for them to remain with the business….they’ll have an incentive to improve risk management practices, minimizing claims made by the business against the CIC. “ To read more about funding deferred compensation via a captive insurance company, CLICK HERE.
Consistent with our message, Clark makes it clear that captive insurance companies must be formed with legitimate business purpose. The primary purpose should be to improve risk management. Captives should not be formed primarily for tax benefit reasons. Nevertheless, she notes that a properly structured captive has rock solid legal footing, and she reviews case law where the Internal Revenue Service (IRS) has repeatedly lost in its attacks on captive arrangements. One case she cites is the recent Rent-A-Center case where the appliance and furniture renter’s aggressive captive arrangement was upheld by the U.S. Tax Court in a mutli-pronged challenge by the I.R.S. Needless to say, captive insurance companies set up by CIC Services are far more conservative than the Rent-A-Center captive. To read our January 2014 write-up on the Rent-A-Center case, CLICK HERE.
Consistent with our approach to captives, Celia notes that captives should not be formed for the purpose of pursuing any particular investment strategy. Captive assets should be managed based on their ability to pay potential claims. As an example, Clark notes, “A CIC that’s formed to create a fund of pre-tax monies for investment in property available for the personal use of the business owners or employees wouldn’t be considered valid by insurance regulators or tax authorities.” While a captive insurance company is free to choose its investment strategy for the most part, the strategy should always protect the claims paying ability of the captive. Captives have great flexibility in investment vehicles and asset classes. However, a captive shouldn’t be formed to solely support investment in one asset class. As an example, Celia notes that captives should not be formed solely to purchase life insurance on the business owner. She does note that, “Life insurance, as a captive investment, isn’t illegal and, in many ways, is well-suited as an investment of a small CIC.” For many captive arrangements, we recommend business owners consider life insurance as an asset class in their captive for the same reason that many large banks invest large portions of their tier on capital in BOLI (bank owned life insurance) and many large corporation CFOs invest in COLI (corporate owned life insurance), particularly for thee deferred comp programs for key executives. To read our perspective on life insurance as an asset class in a captive, CLICK HERE.
CIC Services is a small and mid-size business champion. We have been helping business owners own their own insurance company since 2005.