1. Possibilities and Pittfalls
831 (b)s
Possibilities and Pittfalls

2. Discussion Items Micro Captive Basics Does your captive “quack”?
Story of PGIC
Story of 3MP
Quack?

3. Honigman Miller Schwartz and Cohn LLP
Michael Domanski
Honigman Miller Schwartz and Cohn LLP
Partner

4. What is a captive?
A captive is a licensed insurance company that commonly has a limited purpose to provide coverage to related / unrelated insureds that have relationships with the owners and / or “sponsor” of the captive
Captives are evident across industries and have been used for over 30 years by healthcare providers to fund medical malpractice risk and other risks

5. SPCs / Cells / Series LLCs
Domestic Cells / Series LLCs
Each cell within a cell company is treated as a separate corporation for tax purposes
Each series within a series LLC is classified as a separate partnership (if two or more members in the series), a disregarded entity (if only one member) or a corporation (if it so elects)
Foreign Cells
Each cell within the cell company conducting sufficient insurance business is treated as a separate corporation and therefore, eligible to make certain elections (e.g., a “domestication” election); otherwise, “non-insurance cells” are classified as an unincorporated division of the overall captive
“Grandfather Rules”
Some “insurance” cell captives established before 2010 can qualify as one consolidated corporation (contrary to the current rules)

6. Federal Tax Criteria for a Captive / Four Elements of Insurance
Arrangement can qualify as insurance if the following elements are satisfied:
Existence of an insurance risk (sufficient fortuity, more than an investment risk)
Insurance in the commonly accepted sense (arm’s-length / commercial-like transactions)
Risk shifting (lack of parental guarantees, adequate capitalization)
Risk distribution (many insured parties)

7. What is an 831 (b) or “micro“ captive?
831(b) refers to the section of the Internal Revenue Code related to insurance companies
Premiums cannot exceed $1.2 million
If it applies, federal income taxes are imposed on the captive’s investment income only
The premiums of other captives with similar ownership can be aggregated for purposes of the premium limitations
A complicated series of “attribution” rules can apply for purposes of the ownership tests

8. What is the recent buzz about these entities?
IRS was recently successful in obtaining the support of an Illinois U.S. District Court in enforcing summonses issued to Artex Risk Solutions, a multi-domicile captive manager, in connection with an audit of a large group of micro captives
Increased IRS audit activity reflects the IRS’ close monitoring of the proliferation of micro captives that are involved in third party “pooling” structures and supports its public comments that it is concerned that such arrangements may not possess the necessary attributes of insurance or valid business fundamentals

9. What is the recent buzz about these entities?
IRS rejected late last year several private letter ruling requests from taxpayers participating in captive pooling arrangements
The IRS indicated in its rejections that it was revisiting whether non-traditional coverages could constitute insurance for tax purposes and was unwilling to validate transactions when more specifics were required to assess whether risk transfer/risk shifting had been achieved
Such an approach was a drastic departure from the successful rulings that had been previously issued by the IRS in the context of substantially similar structures

10. Alliant Insurance Services, Inc.
Lorraine N. Lewis
Alliant Insurance Services, Inc.
Executive Vice President

11. Does Your Captive Quack?
Consulting team selection
Domiciles
Product selection
Participation in risk pools
Documentation
Capitalization
Distributions / loan backs

12. Best Practices – Evaluating a Start Up
Feasibility study
Legal review
Tax and accounting review
Actuarial review
Insurance market review
Selection of professional consulting team
Selection of appropriate domicile
Decision to incorporate

13. Malcolm T. Donnell
PGIC, LLC.
Shareholder

14. Physicians Guaranty Insurance Company
Writes policies to insureds involved in the provision of healthcare services
Captive was created to cover medical professional liability and other risks
At one point retained and funded up to a $5M SIR
Conducted LPT and medical professional liabilities out of the captive due to changes in market
Management conducted diligence to determine if the captive remained a viable option

15. Physicians Guaranty Insurance Company
Management decided to maintain captive:
To continue to cover risks other than medical professional liability
To cover medical professional liability when market conditions changed
Movement of medical professional liability risk from captive into commercial market reduced captive premium
Resulting premium less than $1.2M
Captive meets definition of Section 831 (b) due to premium size

16. Bubba Beyer
3MP, LLC.
Shareholder

17. 3MP, LLC
Insureds of the captive provide road paving and engineering services to home builders and developers
High growth company with positive loss performance
Owners wanted to explore alternative risk financing and insurance strategies
Use of commercial insurers often results in the “trading of dollars”

18. 3MP, LLC Diligence and feasibility included:
Interview and selection of professional providers (actuarial, captive managers, legal and regulatory counsel, audit and tax counsel)
Intentional selection of mature domicile
Development of business plan, product selection and actuarial study
Program refined based upon commercial market conditions and implemented accordingly