Evolving trends in captive insurance.

• Author: Baxley, Jean

Recent tax developments relating to captive insurance companies present potential new opportunities for some captive arrangements while raising caution about others. The Tax Court opinion in Securitas Holdings, T.C. Memo. 2014225, addressed some issues that have been concerning taxpayers and their advisers and provides helpful guidance to corporate taxpayers wishing to set up or maintain tax-viable captives. At the same time, coordinated IRS audits of "micro-captive" promoters are proceeding. In light of the current volume of activity involving captives, it is important to focus on satisfying the insurance fundamentals, which include insurance risk, risk shifting, risk distribution, and insurance in its "commonly accepted sense." This item highlights current, practical considerations regarding qualification of a captive as an insurance company for federal income tax purposes.

Background

In today's global, high-technology business environment, the risks facing enterprises are especially complex. For some risks, required commercial insurance coverage may be difficult to secure in the marketplace or, if available, prohibitively expensive. To meet their risk management and cost management objectives, many companies choose to retain significant risk and use other approaches in addition to, or as an alternative to, procuring commercial insurance. The use of a captive insurance company is one such alternative.

Captives take various forms, but they are typically established and operated to provide insurance coverage to affiliates, e.g., the parent company of the captive, the captive's brother/sister companies, or a particular group. Various types of captive structures may be used, including single-parent captives, group/association captives, risk-retention groups, agency captives, and protected cell companies. A captive can be formed and subject to the insurance regulatory regime in a foreign jurisdiction or domiciled in the United States--possibly in a captive-friendly state such as Vermont, South Carolina, or Utah.

In addition to fulfilling an enterprise's risk management objectives, a captive that qualifies as an insurance company for federal income tax purposes offers tax benefits to its owner or owners and affiliated group. That is, premiums paid for the insurance coverage provided by the captive are deductible to the affiliate, while the captive insurance company may defer recognition of unearned premiums (albeit with a 20% "haircut") and deduct unpaid (discounted) losses.

The Current State of Tax...