1. ENTERPRISE RISK CAPTIVE INSURANCE COMPANIES: RISK MANAGEMENT TOOLS FOR FAMILY HELD BUSINESSES AFHE 2018 ANNUAL CONFERENCE APRIL 20, 2018
Jeffrey K. Simpson Gordon, Fournaris & Mammarella, P.A. (302)
David M. DiMayo Oxford Risk Management Group (410)

2. Objectives: Define and describe Enterprise Risk Captives
Show how they can help family held enterprises
Explain how they work
Discuss tax issues and how to avoid them

3. What is a Captive? Property & Casualty Insurance Company
A risk management tool utilized to cover the unique risks of an operating company
Provides coverage for specialized risks which may not be available or may be too costly to obtain through traditional insurance providers
A bona fide insurance company, subject to approval and regulatory oversight by the insurance regulators in a chosen domicile

4. Common Types of Captive
Member Owned Group
Risk Retention Group
Traditional Pure Captive
Enterprise Risk Captive
Today’s
Focus!

5. What is an Enterprise Risk Captive?
Serves private company/family held business
Covers non-traditional risks and gaps in commercial coverage
Elects special treatment under IRC Section 831(b)
Also may be called
Small Captive
Micro-Captive
831(b) Captive

6. What are non-traditional risks?
Traditional Risks – things typically covered
Workers Comp
Auto
General Liability
Professional Liability
Property Damage
Non-Traditional Risks – things NOT typically covered
Exposed but uninsured
Loss of business income
Gaps in commercial coverage
Deductibles
Exclusions

7. Insurable Risks That May Result in Loss of Business Income
Mechanical Breakdown
Loss of Key Employee
Loss of Licensure
Legislative and Regulatory Changes
Reputational Risk
Suppliers/Supply Chain Interruption
Business Interruption
Contract Penalty and Failure to Perform on Contract
Deductible Reimbursement
Defense Cost Reimbursement
Difference in Conditions

8. Basic Captive Structure
Shareholders
Operating Company
Insurance Premium
Captive Insurance Company
Insurance Coverage

9. Why Implement a Captive? Risk Management and Other Benefits
Greater Control over Claims
Fill Gaps in Existing Coverage
Underwriting Flexibility
Incentive for Loss Control
Reduced Insurance Costs
Capture Underwriting Profit
Pricing Stability
Purchase Based on Need
Investment Income
Access Reinsurance Market
Improved Claims Review and Processing

10. Underwriting Assemble Current Insurance Information
Review Current Policies and Endorsements
Analyze Five Year Loss Runs
Three Year Summary of Coverage
Identify Trends in Premium History
Underwriting
Understanding the operating company
Discuss reasonable coverage applicable to industry and unique business
Identify Self-Insured Exposures
Identify Uninsured Loss Experience
Adequacy of Policy Limits

11. Third Party Review and Analysis
Independent Third Party Risk Analysis
Coverage Chart
Gap Identification
Total Cost of Risk (TCOR) Analysis
Enterprise Risk Exposure Review
Risk Selection
Review by Independent P&C Broker
Identify Relevant Coverage
Avoid Duplicate Coverage
Independent Third Party Actuarial Analysis
Rate Promulgation
Peer Review of Pricing Methodology
Feasibility Study

12. Flexible Ownership Options
Operating Company
Insurance Premium
Fronting Carrier
Underwriting
Profit *
Insurance Policy
Premium
Reinsurance
Captive
Captive Owner
Dividend Distributions
Flexible Ownership Options
*After Claims less Expenses

13. Claim Example: First dollar risk sharing
Fronting Carrier
$1,000,000 Claim from Participant Insured
$1,000,000
Claim
Captive which filed the Claim
$200,000
20% of Claim
$800,000
80% of Claim
All Other Captives Share Risk
Your Captive
$1,600
Assumptions:
Your Captive Premium is $1,000,000
Total Written Premium = $500MM
Your Portion of Claim = 0.2%
Your Captive is Responsible for $1,600

14. Tax treatment How does 831(b) work? Current IRS environment
Managing to be conservative and avoid abuse

15. How does 831(b) work?
Insurance company taxed only on investment income and not on premium income, if:
No more than $2.3 million annual premium
($2.2 Million Plus Inflation index)
AND
2. One of two diversification tests:
No more than 20% of risk from a single policy holder OR
No estate planning ownership structure
(Generally, no wealth transfer, lineal descendants cannot own more of captive than insured enterprise)

16. Current IRS Environment
Abuses? What the IRS Doesn’t Like Deferral + Conversion = Recipe for Mischief
Premiums
No Actuarial Support
Inflated
Coverages
Business Risk
Bogus Risk
Pools
Low Loss Ratio
Premium Allocation
Tax Motivation
Promoters
Estate Planning

17. Current IRS Environment IRS Activity
Dirty Dozen List
Evolving Language
Notice
Overbroad?
Audits
Owners and managers
Tax court cases
Avrahami
100s to follow

18. Current IRS Environment
Industry is engaged – ongoing dialogue
Educating IRS and DC on insurance
Results
PATH Act increased limit and restricted only estate planning
PATH Act clarifications passed in March, 2018
Notice filing deadline delayed

19. Enterprise Risk Group Captive Solution
Alternative Risk Finance Solution to 831(b)
Coupling a Traditional Captive Insurance Design with ERM
Provides a Mechanism to Achieve Similar Risk Management and Economic Goal/Objectives
Pros and Cons

20. IRS Scrutiny AVOID DOING THESE THINGS!
Not Following the Safe Harbor Guidelines
No Real Distribution of Risk
No Claims Experience or Claims Layering
High Deductible Risk Pools or Retroactive Policy Issuance
Lack of Business Purpose
Lack of Independent Actuarial Analysis
Paying Excessive Premium for your Coverage
Insuring Unreasonable Risks
Treating Captive Assets as a Personal Checkbook
Circular Transactions
Investment Plans that Don’t Make Sense

21. Implementation Process
Initial
Consultation
Informal
Feasibility
Analysis
Engagement
Process
Risk Analysis, Underwriting and Compliance
Domicile Selection
Complete
Study
Application to Insurance Regulators
Approval Process
Closing Procedure

22. *Advisors are independent of Oxford
Captive Manager
Legal Counsel
P&C Broker and Risk Analysis Firm*
Financial Advisor*
Tax Counsel*
Audit
Firm
Actuarial
*Advisors are independent of Oxford

23. Across All Industries:
Significant Annual Recurring Revenue
Enterprise Risk Exposure
Willing to invest time to explore risk management solutions
Sophisticated business owner
Across All Industries:
Agriculture
Transportation/Logistics
Construction
Entertainment/Professional Athlete
Medical
Real Estate IT
Oil Drilling
Manufacturing

24. How to Build a Conservative Captive
Design with risk management as the primary focus
Adhere to IRS Revenue Rulings and all available guidance
Assure that the captive is operated as a bona fide property & casualty insurance company with meaningful claims
Underwrite policies that offer coverage at appropriate premium levels
Avoid structures that are “too good to be true” in order to generate predictable results

25. Questions? Jeffrey K. Simpson David M. DiMayo
Gordon, Fournaris & Mammarella, P.A.
(302)
@JeffreyKSimpson
David M. DiMayo
Oxford Risk Management Group
(410)