A New Standard for the Captive Industry

Dennis Silvia, Cedar Consulting

The beginning of a new year always causes me to think back over the previous year, and in the captive insurance world there has been a lot happening.  Captives continue to be a target for the IRS and they have been successful in winning cases against a couple of egregious captive structures.  This environment has opened the door for major participants in the captive world to face civil litigation regarding their structuring and management of captives.  States are trying to balance their budgets taxing the premiums of captive of insurance entities.  All of this is creating the impression that the industry is in peril, however the optics do not reflect accurately on the real health and vitality of captive insurance.  From the inside of the industry I can say that I am as busy as I have ever been over my nearly 30 years of experience and I see lots of growth potential in the market as we bring to bear the concepts of alternative risk transfer to the emerging risks of today.

The majority of captive insurance practitioners take their role in the development and management of captive insurance entities seriously.  They recognize that a captive is, at its foundation, an insurance company.  It is a mechanism that allows for efficient risk finance and it can be the beating heart of a centralized and effective risk management process.  They also recognize that it isn’t primarily a tax avoidance scheme or wealth management tool.

Most of the negative attention on captives has been focused on the 831(b) Micro Captive.  The elements of the law that enabled 831(b) companies gave them some unique abilities to contribute to their success as a risk management tool for smaller businesses, including the ability to avoid taxation on underwriting profits at the captive insurance company level.  The problem comes when “tax free” is the headline and insurance programs are reverse engineered to accomplish tax avoidance as the primary goal instead of risk management.  Then we see abuses like millions of dollars of enterprise risk management premiums for exposures that don’t exist mixed into pools that will never have a loss for a company that pays $100,000 in traditional guaranteed cost premium.  The non-insurance practitioner thinks he has checked all the boxes but doesn’t realize that the most important boxes — reasonableness and purpose — are left unchecked and will eventually lead to problems down the road.

I happen to believe that in most cases these kinds of mistakes are based more on the enthusiasm and inexperience of the promoters who think they have found the holy grail of tax avoidance than on a desire to defraud clients.  To this witches brew we add a dangerous and powerful catalyst: the desire for most businesses to want to mitigate their tax exposures.  In this environment even the most conservative businesses throw caution to the wind and don’t even perform basic diligence on what they are being offered by the tax avoidance zealots.

We could come to the conclusion “Buyer Beware” except that the problems associated with these types of programs reflect badly on all of us in the industry and actually contribute to a perception of fast dealing and tax hustling that is already hurting the industry from a political perspective.  But what can we do?

May I suggest that a sanctioning body be raised up that provides a unique course of training and a code of ethics that members must adhere to for participation. Members of this professional group of captive insurance practitioners would be able to indicate their participation and training in their marketing materials and hopefully the client community interested in captive insurance programs would seek them out.    It would draw a bright line between legitimate captive insurance practitioners and those who are merely captive insurance promoters.

I would love to hear what other industry professionals think of this idea.