When a Cell Captive Becomes a CELL Captive
[The below is a parody designed to make an important point. It is NOT intended to reflect on the character or motives of any actual managers of protected cell, segregated cell or incorporated cell captive insurance companies. Rather, it is designed to emphasize that, in some cell captive structures, the interests of the captive manager and captive owners are not well aligned. And, when friction points develop, it is the captive manager – and not the captive owner – who usually holds all the leverage. Not all cell structures are problematic in this regard, but many are. Pre-formation diligence is a must.]
The following excerpt is from the diary of Ty M. Goode, a captive manager with Shackelford Captive Solutions. Shackelford specializes in cell captive insurance companies and their tag-line is “We Take the Word CAPTIVE To A Whole New Level.”
Monday, February 8th
I received another voicemail today from Mr. Jones, one of our cell captive “owners”, complaining that he has an important question, that we won’t return his calls, and that he wants to fire us in favor of another captive manager.
What? Fire us!? Seriously?! He just doesn’t get it. There is no “firing” us, and he doesn’t really “own” his captive, at least not in the sense of being able to make decisions like about it like, you know, who gets paid to be the captive manager. Rather, Shackelford Captive Solutions owns the captive. Mr. Jones just rents some space, or a “cell”, within it. He’s not going anywhere soon. Maybe I’ll call him back tomorrow.
Wednesday, February 10th
That pesky Mr. Jones left another voicemail. He was quite upset after reading the email I sent him yesterday letting him know that he can’t fire us, and apparently he was even more upset when I left him a voicemail that we’ll be charging more to manage “his” captive this year. He says he won’t pay our fee since we won’t do what he wants, but…he will. Just like all the others who have complained about our fee increases in recent years, he Mr. Jones will pay. If he doesn’t, we won’t do the captive management work. And, if we don’t do the work, the regulators and IRS get very angry. Not with us, dear diary, but with Mr. Jones.
Yes, he will pay.
Thursday, February 11th
I never returned Mr. Jones’s call after the voicemail he left yesterday refusing to pay us. So, guess what he did next, dear diary? He left another voicemail today.
This time he says that he’s going to form a new captive in another jurisdiction and merge “his” current one into the new one on a tax-free basis in order to get rid of us.
Wishful thinking! As I reminded him a few days ago (at least I think I did), he doesn’t “own” his captive. He just rents some space in OUR captive. That is, after all, what it means to be in a “cell” captive. So, the real captive owner, calls most of the shots. We decide who manages the captive, and we choose…us. We decide where the captive is domiciled. We decide what risks the company will insure. We are the wardens of this captive insurance company.
“Cell”. “Captive”. “Warden”. Jail! Ha! I never thought really thought of things that way before, but…how true!
What he hasn’t figured out yet is that, because he simply rents space in our protected cell captive, there is no separate legal entity for him to “merge” into his new captive. So, there can and will be no “merger”. The only way for him to escape us is to liquidate his cell. And liquidating his cell triggers taxes. Lots of taxes. These taxes are definitely a “barrier to exit”. Sometimes a cell truly is like a jail!
Friday, February 12th
Another client, Mr. Davis, left a voicemail today. At least it wasn’t Mr. Jones again!
Mr. Davis is upset because the state that regulates Shackelford is clueless. The state used to be quite reasonable—both licensing and regulating captives effectively. But a new Governor was elected a few months ago, and he appointed his incompetent political ally as Insurance Commissioner. He also cut the budget for the Department of Insurance, and being one of the smaller sections of that department, the Captive Division bore most of the brunt of those cuts. The Captive Division is now staffed by low-paid amateurs who have no clue what they are doing.
Consequently, since Mr. Davis can’t move his cell on his own, for the same reason that Mr. Jones couldn’t, Mr. Davis wants us to re-domicile ALL OF SHACKLEFORD to another jurisdiction, one with more experience and competence. Hey, that would be great in…LaLa Land! But, I don’t live there. Does Davis have any idea what a pain it would be, and how expensive it would be, for us to move all of Shackelford? We have almost 200 cells under our company!! Each of them would have to cooperate in some form or fashion. They’d each have to complete new paperwork and be approved by the new jurisdiction.
What a pain! A hugely expensive pain! Not going to happen. We’ll just have to suck it up and live with the state we’re in now.
Monday, February 15th
We received another question today from another frustrated client. He wants his cell within Shackelford to invest into an LLC, along with another captive that he owns, so that the LLC could pool the assets of the two captives, achieve some economies of scale, and benefit from common asset management.
But, Shackelford has an investment policy statement in force that doesn’t really permit investments into subsidiaries. Could we change that policy? Sure. But, that changes the rules for all the other cells too, and that could open Pandora’s box. In any event, it creates a lot more work for me, work that I don’t have time to do since I’m now spending half my days explaining to clients why the cell structure they have won’t let them do what they want to do, and why they can’t get out of that cell structure without major tax implications. Very frustrating!
Tuesday, February 16th
It’s really going to hit the fan around here. We just got an audit notice from the IRS.
Shackelford is being audited, which is bad enough. But, if history is any guide, the IRS will also audit each of Shackelford’s insureds! We have almost two hundred cells, each of which has at least one insured! That’s hundreds of audits. Hundreds! Every business owner that formed a cell with us is likely to get audited, at the business level and maybe personally. We are in for an avalanche of complaints. But really, what do they expect? Cell “owners” don’t own their own insurance company and don’t have their own insurance license. They all share one license. When one cell sharing the license gets audited, they usually all get audited. This is going to be one big nightmare.
A “captive insurance company” is so named because that insurance company is formed primarily to insure the risks of a group of RELATED businesses. The insurance company exists to serve the needs of those related businesses, and they have near complete control over the insurance company. They can decide where it’s domiciled. They can hire and fire the captive manager at will. They decide which risks are to be insured, etc. Thus, these insurance companies are “captive” to the interests and needs of the RELATED businesses, hence the name.
But cell captives are not really captives, at least not in the same sense. With a cell captive, ONE insurance company insures the needs of dozens or even hundreds of UNRELATED businesses, none of whom actually have much control or say-so over the insurance company itself. Each business is simply the beneficial owner of one piece, or “cell”, within the overall company But the insurance company itself is not, therefore, captive to the interests of those insured businesses, and those businesses have relatively little say-so over its operations. Rather, the captive manager controls most everything.
When a real captive gets audited by the IRS, it’s only the captive itself and its related insured who get audited. But, when a CELL captive gets audited…phew! EVERYONE probably gets audited. Each of these businesses will want or need their own representation in these audits. That’s hundreds of CPAs or attorneys all involved and all need to coordinate their efforts to ensure the best outcome. Imagine the cost!
CIC Services has been working with cell captive owners to help them transition to stand alone or pure captives as part of our CAPTIVE RESCUE program. If you or a client you advise are in need of RESCUE, please give us a call. The sooner the better!