CHAPTER VII — CAPTIVE INSURANCE
This is about risk management. If you manage your own risk, you retain your privacy because you are not sharing a large amount of identifying information to a third party, which is essentially a banking institution. We can do the same things using lending that we can in captive insurance, but I’ll leave that explanation for another time as I’m probably just introducing this to you for the first time.
The term “captive insurance” is not a statutory or legal term, but it makes a distinction from other types of insurance.
A Captive Insurance Company is an insurance function or company that primarily insures the risks of businesses which are related to it through common ownership. For example, the owner or a group of businesses can form a wholly owned Captive Insurance Company for the purpose of insuring his related companies. The insured businesses pay premiums to the Captive in exchange for insurance. The Captive can be owned by the business owner, his spouse, his relatives, a trust, or any of the companies he owns. You can read more about this in The Asset Protection Book.
I have used my own form of “captive insurance” to provide my own automobile insurance needs. It’s not a licensed business and has no reinsurance, although it could if I wanted it to, but for the tiny $40,000 liability, it just makes sense to have the liquidity set aside for that purpose. I use gold and silver to maintain liquidity without losing to inflation. In fact, my insurance company has made quite a bit of money for me over the last ten years. It even paid for a two month vacation to Europe for nine family members, that vacation literally cost me nothing because of my car insurance arrangement.
There are way of making nice returns on your money with captive insurance, I can’t get into that much detail here, but I will share with you how it can be used to manage one personal liability.
It is possible and preferable to carry your own car insurance. The benefits are many and detriments few, but it’s not for everyone. You need the cash or property that can be deposited or encumbered by a third party in order to meet the state’s legal requirements. You must pay to fix that scratch or dent on your car. But you can avoid the unfair dictates of the typical monopoly insurance carrier, such as having them insure all of your cars and requiring every adult to have a driver license and be on the policy for the household.
You also retain control over how much or if any money will be paid for the minor parking lot collision. Being self-insured gives you better privacy, for example, you can establish residency in another state while you live in your state in order to meet the lower insurance standards. This is not the only reason of course.
I believe that being self-insured demonstrates that a person is socially and morally responsible. This is a greater degree of responsibility that falls upon the self-insured instead of the typical insurance arrangement where everyone cries to their insurance company for every little incident, and then drives too fast, talks on the phone while driving and hopes that their insurance will make up for their irresponsible behavior.
Detail of Being Financially Responsible
Rights and Privileges
You have probably heard someone tell you that “driving is a privilege”. I don’t profess to know how this propaganda got into circulation, but let’s just agree that it’s nothing more than propaganda. I’ll explain.
First, people, not corporations or businesses, people have the absolute right to travel, this includes the use of a machine or other mechanism or mechanical device or animal powered carriage as a means of conveyance. I’m going to spare you the legal citations and statutory gibberish intended to confuse the issue. The summary of it all is that if you are not using the public and private road ways in the furtherance of a commercial enterprise, then you are not operating a motor vehicle, you do not have passengers and you are not “driving” as these terms are defined by any statute in the 50 states. Instead, you are traveling in your private property, in a private means of conveyance and sometimes with one or more guests (people traveling with you who are not paying you for the ride).
Recognizing that you are traveling by right, you have a greater personal responsibility or obligation to drive safely, following the speed limits designated by engineers, using and abiding by the appropriate lights and signals and yielding properly. traveling by right imposes a much greater responsibility on you than those traveling under a privilege given to them by the state, the taxing authority.
Privileges are licenses or taxes imposed upon corporations or businesses because these “entities” do not have a conscience. The legal definition of corporation is an insane person. This is for the protection of people, the citizens who choose to govern themselves through elected representatives or agents. A corporation is a creature without a conscience that must be regulated by those with a conscience (a moral awareness) for the protection of the people. The reason I say that people have a greater obligation to travel safely than those who are rightly regulated is because people have a moral awareness and therefore a moral obligation to other people. They are expected to know right from wrong whereas a corporation is not, and cannot know the difference.
The driver license, any license, is a tax; it is a tax on the privilege of doing business. As long as you are not engaged in the furtherance of any commercial enterprise, then you are not involved in a licensed activity. Although nearly every one of us uses a “license to drive”, it is because the system that has developed under the executive branch will make our lives miserable if we are caught without paying the taxes like all of the other businesses, so that we can be treated with the assumption that we are driving and engaged in the furtherance of a commercial enterprise.
There, you’ve probably heard bits of this before, but I’ve put it into a few short paragraphs of words and I hope it is enough. One other note, I have personally won the “right to travel’ in court, meaning, that I have established in a court of law that I had the right to travel, drive in my car, without a license or registration. That is, without paying any taxes to the state, city or county. You will not find this case published anywhere, it took a three hour trial, and the trial was conducted after the court had closed. You can choose to believe me or not, but this is the truth and it is my motivation for writing this book. Fifteen of my friends had remained after hours to hear it for themselves.
You will find that many of the state statutes regulating financial responsibility and proof of it pertain to fleets of vehicles. The reason for this is what I explained earlier, a motor vehicle is a means of conveyance which is used in the furtherance of a commercial enterprise.
The legal requirement at a traffic stop is that you show evidence of financial responsibility. This means a valid insurance card, it doesn’t mean you must show a handful of $100 bills that you can readily pay an injured party. The police officer or sheriff is only interested in you presenting acceptable evidence that you can be held financially responsible for injury you might cause.
The same is true of a driver license. You are expected to always carry this with you while driving, but a valid receipt that you paid the license tax or fee to the county and state is also acceptable. A license is nothing more than a receipt or other evidence of payment of the tax.
You might think at first that residency has little to do with driving and insurance and state regulation; however, it is the sole means by which the authority to require insurance and licensing is promulgated. Residency establishes eligibility for statutory benefits and therefore, liability for licensed activities. I like to say that regarding statutes and state administered programs and privileges, “eligibility creates liability”. If you are eligible for a license, you are liable for the conditions there under.
You became a resident by doing certain things, or engaging in certain activities. These might include personally owning real estate in a county, registering to vote, enrolling your children in the public school system, obtaining a professional license using your residential address on the application. Your residential address can be for leased property or owned property, if you reside at a location, in one county for more than a certain number of months during the year continuously, like six months, you can be considered a resident. You can be a member of a state chartered organization and establish residency.
The reason why I mention this, in fact dedicate an entire chapter to the subject, is because while you are by default a resident where you are currently a resident, you can change your residency, especially when you are self-insured. The purpose of changing your residency would be to benefit from different insurance requirements. For example, Florida has about the least money requirements for insurance.
Statutory Insurance Requirements by State
The first two numbers refer to bodily injury liability limits and the third number refers to the property damage liability limit. For example, the first two numbers in 25/50/20 would mean in an accident each person injured would receive a maximum of up to 25,000 with only 50,000 allowed per accident (ex. 2 people needing 25,000, if the need is more such as 3 people needing 25,000 then whoever files first gets first access to the 50,000 limit and you may be sued for the rest if the accident was your fault!). The last number refers to the total coverage per accident for property damage which in this case would be 20,000.
Alaska 50/100/25; Alabama 20/40/10; Arkansas 25/50/15; Arizona 15/30/10; California 15/30/5; Colorado 25/50/15; Connecticut 20/40/10; Delaware 15/30/5; Florida 10/20/10; Georgia 15/30/10; Hawaii 20/40/10; Idaho 20/50/15; Illinois 20/40/15; Indiana 25/50/10; Iowa 20/40/15; Kansas 25/50/10; Kentucky 25/50/10; Louisiana 10/20/10; Maine 50/100/25; Maryland 20/40/10; Massachusetts 20/40/5; Michigan 20/40/10; Minnesota 30/60/10; Mississippi 25/50/25; Missouri 25/50/10; Montana 25/50/10; Nebraska 25/50/25; New Hampshire 25/50/25; New Jersey 15/30/5; New Mexico 25/50/10; Nevada 15/30/10; New York 25/50/10; North Carolina 30/60/25; North Dakota 25/50/25; Ohio 12.5/25/7.5; Oklahoma 10/20/10; Oregon 25/50/10; Pennsylvania 15/30/5; Rhode Island 25/50/25; South Carolina 15/30/10; South Dakota 25/50/25; Tennessee 25/50/10; Texas 20/40/15; Utah 25/50/15; Virginia 25/50/20; Vermont 25/50/10; Washington 25/50/10; Wisconsin 25/50/10; West Virginia 20/40/10; and Wyoming 25/50/20.
The following excerpt is from the State of Ohio pertaining to its proof of financial responsibility requirements. There was no special reason for choosing Ohio other than it is consistent with requirements in other states. I also give examples from Maine and New Hampshire. I could have chosen Florida or California instead. You should research your own state’s requirements for proving and meeting financial responsibility.
Financial Responsibility Requirements
To comply with the FR requirements, Individuals must maintain one (1) of the following:
A motorist liability insurance policy. Insurance cards are issued by an insurer to the policy holder for each motor vehicle insured under a motor vehicle liability insurance policy;
A $30,000 bond issued by an authorized surety or insurance company;
A certificate of proof of financial responsibility signed by an insurance agent on a form prescribed by the Ohio Bureau of Motor Vehicles (BMV);
A certificate issued by the BMV, after proper application and approval, indicating that money or government bonds in the amount of $30,000 is on deposit with the Ohio Treasurer Richard Cordray;
A certificate of bond issued by the BMV, after proper application and approval, in the amount of $30,000 signed by two (2) individuals who own real estate having equity of at least $60,000;
A certificate of self-insurance issued by the BMV, after proper application and approval, to those with more than 25 motor vehicles registered in their name or a company’s name.
Verification of Proof of Financial Responsibility
Ohio’s FR law requires every applicant for registration of a motor vehicle and every applicant for a driver’s license, or the renewal of such license, to sign a statement indicating that the applicant maintains, or has maintained proof of financial responsibility at the time of application, and the applicant will not operate a motor vehicle in Ohio without maintaining proof of financial responsibility.
Proof of financial responsibility is required to be verified under the following circumstances:
When an individual or a motor vehicle owned by the individual is involved in a motor vehicle accident that results in bodily injury to or death of any individual or more than $400 of property damage and a complaint is filed with the BMV alleging that the driver or owner was uninsured at the time of the accident. The law permits the driver of any motor vehicle “which is in any manner involved” in such an accident to forward, within six months of the accident, a written report to the Registrar alleging that a driver or owner of any other vehicle involved in the accident was uninsured at the time of the accident. The BMV must send notice of the allegation to that driver and owner. Within 30 days after the mailing of the notice, the driver or owner must forward a report and acceptable proof of financial responsibility to the BMV.
When an individual receives a traffic ticket indicating that proof of the maintenance of financial responsibility was not produced upon the request of a peace officer or State Highway Patrol trooper during the enforcement of Ohio traffic laws or during a motor vehicle inspection. The individual must submit proof to the traffic violations bureau with payment of a fine and costs for the ticketed violation or, if the individual is to appear in court for the ticketed violation, the individual must submit proof to the court.
Whenever an individual is found guilty of a violation of a traffic offense that requires a court appearance. The court must require the individual to verify the existence, at the time of the offense, of proof of financial responsibility covering the individual’s operation of the motor vehicle or covering the motor vehicle if registered in the individual’s name.
Whenever an individual is randomly selected by the BMV and requested to provide financial responsibility verification.
Ways to Provide Satisfactory Proof of Financial Responsibility
When law enforcement officers request FR proof and the motorist cannot provide satisfactory proof at such time, they are given a notice explaining the options to provide such proof:
Sending a copy (document displaying satisfactory evidence of FR) when paying the fine;
Bringing FR proof when appearing in traffic court;
Sending FR proof when requested by the BMV.
Failure to comply with proof of FR will initiate a suspension process through the BMV. Failure to respond to a Notice of Suspension will result in an individual’s driving and registration privileges being suspended, even if the individual was properly insured at the time of the traffic stop.
This is another example from the State of Maine.
Title 29-A: MOTOR VEHICLES HEADING: PL 1993, c. 683, Pt. A, §2 (new); Pt. B, §5 (aff)
Chapter 13: FINANCIAL REPONSIBILITY AND INSURANCE HEADING: PL 1993, c. 683, Pt. A, §2 (new); Pt. B, §5 (aff)
Subchapter 2: GENERAL FINANCIAL RESPONSIBILITY HEADING: PL 1993, c. 683, Pt. A, §2 (new); Pt. B, §5 (aff)
§1605. Proof of financial responsibility
1. Requirements. To be accepted as proof of financial responsibility, a policy must:
A. Conform to section 1606, subsection 2; [1993, c. 683, Pt. A, §2 (NEW); 1993, c. 683, Pt. § 5 (AFF).]
B. Include the condition that the obligor must, within 30 days of rendition of judgment, satisfy the judgment in an action to recover damages:
(1) To property or for bodily injury, including death;
Accidentally sustained during the term of the policy by a person other than the insured, employees of the insured actually operating the motor vehicle or another person responsible who is entitled to worker’s compensation benefits; and
Arising out of the ownership, operation, maintenance, control or use of a vehicle within the limits of the United States of America or Canada; and [1993, c. 683, Pt. A, §2 (NEW); 1993, c.683, Pt. B, §5 (AFF).]
C. Be in the amount or limit of at least:
For damage to property, $25,000;
(2) For injury to or death of any one person, $50,000;
(3) For one accident resulting in injury to or death of more than one person, $100,000; and
(4) For medical payments pursuant to section 1605-A, $2,000.
2. Scope of proof. Insurance in the minimum amounts listed in subsection 1, paragraph C must be furnished for each vehicle registered. Separate proof of financial responsibility is not required for a trailer, semitrailer, camp trailer or mobile home, registered to a person required to file proof of financial responsibility, that is covered by a policy on a vehicle registered by that person and provides the coverage required for a motor vehicle liability policy.
3. Methods of giving proof. Proof of financial responsibility may be given by the following methods:
A. By filing with the Secretary of State a certificate from an insurance or surety company;
B. By the deposit of money or securities; or
C. For a corporation, by satisfying the Secretary of State that the corporation has financial ability to comply with the requirements of this subchapter.
4. Money or securities deposited as proof. A person may give proof of financial responsibility by delivering to the Secretary of State a receipt of the Treasurer of State showing a deposit of money or securities approved by the Treasurer of State with a value or amount equal to that required in a policy.
Securities must be of a type that may legally be purchased by savings banks or for trust funds.
Money or securities deposited are subject to execution to satisfy a judgment, but are not otherwise subject to attachment or execution.
The depositor shall also provide evidence that there are no unsatisfied judgments against the depositor registered in the office of the clerk of any Superior Court in this State.
5. May substitute other proof. The Secretary of State shall return or cancel proof on acceptance of other adequate proof of financial responsibility.
6. Operating without giving proof. A person commits a Class E crime if that person is required to maintain proof of financial responsibility and, without authorization from the Secretary of State and without that proof, operates a vehicle or knowingly permits a vehicle owned by that person to be operated by another on a public way.
7. Restricted license. When a person is required to maintain proof of financial responsibility, the Secretary of State may issue a restricted license to that person authorizing the operation of a vehicle as long as the owner maintains proof of financial responsibility.
8. Electronic filing of proof of financial responsibility. The Secretary of State shall implement a system for the electronic filing of proof of financial responsibility under this section.
The point here is that the state just wants those driving cars to have the ability to pay for damages they cause, up to a certain limit.
There are several important conditions that must exist before you can be financially responsible, in terms that are acceptable to the executive branch of government. More importantly, you want to be responsible to anyone you might injure. It’s not my intention to provide specific legal advice on this subject, I can only explain how I and others have met what we believe are the legal requirements and our social responsibility in the matter.
You will first need to be able to provide a deposit with the Secretary of State, Department of Revenue or treasury of your state, depending upon your state’s individual statutory requirements. Each office will issue a certificate to the insured as evidence of financial responsibility. The deposit would be the in the form of cash, securities or possibly real estate as specified by statute. The deposit, bond or security must be easily liquidated or sold in order to comply with the statute in the event payment to a judgment lien creditor was required.
Many others have used a precious metal such as gold or silver bullion. This can be stored by a third party or by the insured. Then a lien should be placed against the property to encumber it so that a judgment lien can be executed against it within the time required by statute. The notice of lien is established by filing a UCC-1 Financing Statement but there must be a security agreement that constitutes the actual lien, such as your insurance policy. The lien holder should be a corporation, the carrier of the insurance policy.
This corporation can be created by the insured, but the insured should not be the exclusive owner. There must be a separation between the insurance carrier and the insured. The lien must be renewed before it expires, usually every two years.
In summary, you will need a corporation, the formation of which can be completed within an hour at a cost of about two hundred dollars. A UCC-1 Financing Statement should be recorded with the Secretary of State along with the security agreement. The filing fee usually fifty dollars. Remember that you must meet the deposit requirements by acquiring the right dollar amount of property to be collateralized, such as silver bullion. Keep in mind that you always retain this money, if the dollar value of silver rises, you will need less silver. If it falls, you will need more. If you need that money returned, you simply replace it with another policy, maybe a traditional one like most people use, or another asset that is permitted by law.
The UCC filing does not involve certification from the state. But you will be able to fulfill your legal requirements if questioned.
Next you will need an insurance card containing all of the information on cards issued by other insurance carriers. You will also need to contact your state’s insurance commissioner and ask for the insurance code for those who are self-insured. In Florida, the code is 11111. The Department of Motor Vehicles will require that your corporation, even if it was registered in another state, be domesticated or registered in your state.
The following is an example of the elements that a valid policy would include. They are taken from the State of Wyoming but are consistent with the requirements of every other state.
A written insurance policy should insure the owner and designate by explicit description or by appropriate reference all motor vehicles with respect to which coverage is to be granted.
It must also insure the person named and, except for persons specifically excluded pursuant to state statute. It must also specify any other person, as insured, using any covered motor vehicle with the express or implied permission of the named insured against loss from the liability imposed by law for damages arising out of the ownership, maintenance or use of the motor vehicle within the fifty states and in some cases, countries bordering the owner’s state of residence.
The policy must state the insured limits exclusive of interest and costs with respect to each motor vehicle, as follows: $x because of bodily injury to or death of one (1) person in any one (1) accident and, subject to the limit for one (1) person, $y because of bodily injury to or death of two (2) or more persons in any one (1) accident and $z because of injury to or destruction of property of others in any one (1) accident.
The policy must insure the person named as insured against loss from the liability imposed upon him by law for damages arising out of the use by him of any motor vehicle not owned by him, within the same territorial limits and subject to the same limits of liability as provided by applicable state law.
It must also state the name and address of the named insured, the coverage afforded by the policy, the premium charged therefore and the policy period and the limits of liability. It should also an agreement or be endorsed that insurance is provided in accordance with the coverage defined in applicable law as respects bodily injury and death or property damage, or both, and is subject to all the provisions of applicable state law.
The motor vehicle liability policy shall not insure any liability under any worker’s compensation law nor any liability on account of bodily injury to or death of an employee of the insured while engaged in the employment, other than domestic, of the insured, or while engaged in the operation, maintenance or repair of any motor vehicle nor any liability or damage to property owned by, rented to, in charge of or transported by the insured.
Most of the policies are subject to the following provisions which need not be contained therein:
The liability of the insurance carrier with respect to the insurance required by this act shall become absolute whenever injury or damage covered by the motor vehicle liability policy occurs. The policy may not be cancelled or annulled as to the liability by any agreement between the insurance carrier and the insured after the occurrence of the injury or damage. No statement made by the insured or on his behalf and no violation of the policy shall defeat or void the policy;
(ii) The satisfaction by the insured of a judgment for injury or damage shall not be a condition precedent to the right or duty of the insurance carrier to make payment on account of the injury or damage;
The insurance carrier may settle any claim covered by the policy, and if settlement is made in good faith, the amount thereof shall be deductible from the limits of liability specified in paragraph (b)(ii) of this section;
The policy, and/or any written application for the policy, and any rider or endorsement that does not conflict with applicable law shall be considered to be the entire contract between the parties.
The policy may provide coverage exceeding that amounts required by law.
The policy may require the insured to reimburse the insurance carrier for any payment the insurance carrier would not have been obligated to make under the terms of the policy except for the provisions of the applicable law.
Any motor vehicle liability policy may provide for the prorating of the insurance thereunder with other valid and collectible insurance.
The requirements of the policy may be fulfilled by the policies of one (1) or more insurance carriers which policies together meet the requirements.
Any binder issued pending the issuance of a motor vehicle liability policy shall be deemed to fulfill the requirements for the policy.
This is the true purpose of insuring against loss and liability, spreading the risk of an individual over a group of individuals. In order to form your own group, each benefiting or insured member must be an owner in the company; otherwise the insurance commissioner may complain that you are unfairly competing with the insurance industry. The membership should not be advertised as insurance, but something like a “financial responsibility club” or a “risk management club”.
I have never formed one of these, but it can be done with a little planning. One of the important considerations is how much if any premiums should be paid. Maybe new members pay monthly or quarterly premiums for two years and then pay nothing more. And then if they make a claim or if a claim is made because of an injury they caused, they might pay some portion of it beyond with the group pays. Another important consideration is how much capital and assets are needed to be maintained by the group at all times.
The business structure itself can be an association or a limited liability company. This is something for the group to decide, but I can tell you this, there is probably no attorney or other professional that will be willing to help you on the entire project. They might be able to answer questions along the way, but most of these people lack the thinking required to act “outside the system”, that is, think for themselves.
Every risk financing alternative, with the possible exception of guaranteed cost insurance, has benefits and risks. The key to success, especially with captives, is to correctly compare the salient benefits with the riskiest drawbacks for each organization.
The National Association of Insurance Commissioners defines a captive as an insurance company that is created and wholly owned by one or more non-insurance companies to insure the risks of its owner or owners—essentially a form of self-insurance whereby the insurer is owned wholly by the insured. Captives are typically established to meet the risk-management needs of the owners or members, and the entities forming captives range from major multinational corporations—the vast majority of Fortune 500 companies have captive subsidiaries—to nonprofit organizations. Once established, the captive operates like any commercial insurance company and is subject to state regulatory requirements including reporting, capital and reserve requirements.
A risk manager must be prepared to make an informed decision regarding whether, and how, an organization should embark on this new path.
Potential Benefits of Captives
Underwriting Profit—For single-parent structures such as captives, underwriting profit is not really profit; it is the tangible economic value of paying less in losses than that which was originally funded. An organization cannot profit from an enterprise in which it sells nothing to independent third parties.
Access to Reinsurance—Twenty years ago a risk manager could not just pick up the phone and call a reinsurer or reinsurance broker—only primary insurance underwriters had direct access to reinsurers. Today, the advantage of being able to access the reinsurance markets still exists with a formal risk financing program such as a captive; it is a matter of degree. At this point we must differentiate between excess insurance and reinsurance. A formal risk financing vehicle has no impact on a company’s ability to access insurers that provide excess insurance. While there are many structural differences between excess insurance and reinsurance, the major point to remember is this: the parent company purchases excess insurance for the captive and the captive itself is the one that purchases reinsurance.
Investment Income—Usually an organization can earn investment returns on only funds it controls. In a wholly-owned captive, for instance, the owner controls the disposition of the loss funds (within certain parameters) until they are paid out in losses. In some off-balance sheet vehicles such as cell captives, the cell captive owner determines the extent to which the policyholder benefits from investment income on its loss reserves. Sometimes the cell captive owner will provide a guaranteed rate of return; other times it might guarantee a range of rates within which the return might fall. The point is that if the organization is going to take advantage of off-balance sheet risk financing there are certain trade-offs, one of which is the amount of investment return.
Usually only one or the other is purchased. So in this sense, if an organization has a formal risk financing program such as a captive, there is a choice.
Flexibility as to Form and Rates—This benefit generally applies only to non-fronted captives. Fronting insurers dictate rates and forms. Regardless of the underlying financing arrangements, fronting insurers remain ultimately responsible for two things: underwriting and claims handling.
Underwriters generally require that the captive adopt their filed coverage forms as their good name is on the policy declarations page. Rates are generally determined by the market in the beginning of any formal risk financing program, but, as time goes by, the captive’s loss experience begins to influence its program’s rates. Direct (non-fronted) programs actually do provide a fair opportunity for the captive to devise its own forms and rates.
Control—Control is a concept that is rarely associated with insurance, but it is one of the most powerful and important benefits of forming or being a part of a captive. For many companies, the expenditures for event risk financing (such as the cost of insurance) seem to disappear into a black hole. Captives and other formal financing arrangements wrest a degree of control away from the commercial insurance markets and allow the policyholder to take an active role in how it pays for the primary-level, reasonably predictable losses. But so does the large deductible or self-insured retention approach; however, that kind of control is temporal. It starts anew each year, and the policyholder gains no ground. In a captive the control grows commensurate with the captive’s assets. The larger the captive’s loss reserves, the greater its ability to assume responsibility (control) for greater amounts of risk over time.
Advantages of Captive Insurance
Increase Control, Reduce Costs
Captive insurance refers to a subsidiary corporation established to provide insurance to the parent company and its affiliates. A captive insurance company represents an option for many corporations and groups that want to take financial control and manage risks by underwriting their own insurance rather than paying premiums to third-party insurers. The advantages of going captive are:
Coverage tailored to meet your needs
Reduced operating costs
Improved cash flow
Increased coverage and capacity
Investment income to fund losses
Direct access to wholesale reinsurance markets
Funding and underwriting flexibility
Greater control over claims
Smaller deductibles for operating units
Additional negotiating leverage with underwriters
Incentives for loss control
Alternatives to the costly practice of trading dollars with underwriters in the working layers of risk
The Vermont Regulatory Advantage
Over 900 companies have already realized the advantages of captive insurance operations licensed in Vermont. In fact, for several years now, Vermont has ranked as the number one captive domicile in the United States and the number three-ranked domicile internationally.
Vermont’s success to date can be attributed to a combination of factors, not the least of which is the ongoing leadership of Vermont’s Governors, both past and present, and both houses of the State Legislature who continue to uphold Vermont’s longstanding tradition of providing solid support for this state’s captive industry. This fact ensures that as captive industry needs change, captive legislation in this state evolves and is further enhanced with timely and meaningful changes made to Vermont captive law.
Vermont continues to be recognized as a quality domicile by captive owners, brokers, regulators, and others in the industry due to its high level of professionalism. An ever-increasing number of companies are further recognizing Vermont as their captive insurance domicile of choice.
The Benefits of Vermont’s 1981 “Special Insurer Act” and the Changes Beyond
In 1981, Vermont realized the potential benefits of attracting captive insurance companies and passed legislation providing the appropriate regulatory and taxation environment. The objective of the legislation was to establish a business friendly climate for companies forming captive insurance operations in Vermont. The law permitted:
Creation of single parent, association and group captives
Reasonable capitalization requirements that may be met with a letter of credit
Coverage of nearly all commercial lines, including excess workers’ compensation, directors and officers liability, plus property and casualty insurance
No approval of rates and forms required
No minimum premiums required
No investment restrictions for pure captives
Favorable premium tax structure
Over the succeeding years, many changes were made to Vermont captive law to both enhance it and to meet the evolving needs of the captive industry.
Numerous amendments were adopted through 2003, when the entire body of Vermont captive law was recodified to streamline pertinent amended statute and to make it more cohesive as well as a more easily accessible body of law. Recodified changes: adopted the Liability Risk Retention Act; permitted fiscal year reporting; added employee benefits and life and health to permitted lines of business, and, for the second time since captive law was adopted, allowed for a significant reduction in captive premium taxes. Other changes permitted reciprocal captives, gave pure captives the ability to insure controlled unaffiliated businesses, increased confidentiality of captive financial records, allowed branch captive formation, and, permitted sponsored captives and the licensing of branch offices of offshore captives.
More recent refinements to Vermont captive statute since the 2003 recodification:
Permitted captives to form as limited liability corporations
Streamlined the process to convert a for-profit captive to a non-profit captive
Established requirements and guidelines to form and operate special purpose financial insurance companies to facilitate securitization transactions and other risk financing structures, including financing Triple-X and AXXX reserve requirements
Clarified the rules for consolidating captives for premium tax purposes
Expanded the definition of persons qualified as sponsors of sponsored captive insurers.
Two “housekeeping” bills, one in 2008 and another in 2009, further fine-tuned various sections of captive statute. The 2008 bill created a more flexible approval process for the use of letters of credit for captive capitalization, set more appropriate financial security standards of the “attorney in fact” of a reciprocal captive company, streamlined the process for the merger or conversion of existing captives to preclude required filings of redundant or unnecessary information, and made additional improvements to the Special Purpose Financial Insurance Company statutes.
While 2009 saw adoption of a premium tax credit for new captives formed in the latter half of 2009, and throughout 2010, the permitted use of International Financial Reporting Standards, and enhancements to the statutes governing sponsored captives.
Vermont will continue to strive to improve and enhance the captive insurance company operating environment through both its innovation and deep understanding of captive insurer risk transfer needs.
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A majority of multinational corporations own one or more captive insurance companies. A captive insurance company is a controlled subsidiary that funds risks of the corporate group, e.g., workers compensation, third party liabilities, employee benefits, property, product recall, extended warranty and many other lines of business. A captive insurance company may be organized in one of the 30+ states (and D.C.) that have enacted favorable laws, as well as in offshore jurisdictions such as Bermuda or the Cayman Islands.
In addition to replacing or supplementing over-priced or hard-to-find commercial insurance, a captive can save on insurance costs for a host of reasons. Captives are a savings tool for harmonizing risk management and claims processing activities globally. They gain access to the commercial (wholesale) reinsurance market. Decisions on investing the captive’s assets remain with the parent.
A captive insurance company can accelerate loss deductions for a corporate group, sometimes dramatically.
A captive qualifying as a true insurance company under IRS and case law standards can provide significant tax benefits in the form of accelerated tax deductions. Taxpayers generally cannot deduct losses for items such as third party claims until payment has been made to the claimant (i.e., before the loss has “accrued”). An insurance company, however, can take a current loss deduction (on a time value of money discounted basis) for reported and “incurred but not reported” losses (as determined by an actuary) before payments have been made. The acceleration benefit may be magnified by having the captive assume payout contingencies for past losses that have not accrued and therefore are not yet deductible in a “loss portfolio transfer” transaction.
Similarly, U.S. owned foreign subsidiary captives may achieve virtually the same tax benefits by reducing the amount of taxable income imputed under the “Subpart F” flow-through rules that apply to so-called “controlled foreign corporations.” The offshore drawback is the imposition of a federal excise tax on premiums paid to most foreign captives, usually at the rate of 1% of the premium (but in certain circumstances the rate is 4% of premiums). Alternatively, qualified offshore captives may voluntarily elect to be taxed as if they were domestic entities and avoid the excise tax without reducing the income tax benefits.
So how does a captive qualify for the tax benefits accorded insurance companies?
The benefits described above are only available for arrangements that qualify as “insurance” from a U.S. tax perspective. Two IRS-recognized alternative approaches exist for achieving insurance status. Under the “unrelated risk” approach, insurance status may be achieved by having the captive cover risks of policyholders not controlled by the corporate group, as well as related party risks. This could include dealers, distributors, and customers. Another option is to participate in “risk mixer” pools with similar captives owned by other multinationals. The second approach, called the “brother-sister” theory, does not require coverage of outside risks. Rather, insurance status can be achieved if the captive funds solely insure risks of sibling entities (as opposed to risks of its direct or indirect shareholders) and enough such affiliates are included in the captive’s risk pool to create “risk distribution.” How many affiliates (the IRS says 12 but at least one appellate case states “several”) and the percentage of risk attributable to any one affiliate (the IRS says between 5 and 15% but captive tax experts use a “less than 50%” test for tax opinion purposes) is still subject to debate. But the insurance positions taken by scores of captives have been sustained under IRS audit in a variety of circumstances.
In summary, a captive insurance affiliate improves the ability of a multinational to reduce its cost of risk, achieve tax benefits and generally control its destiny in a manner unavailable in commercial “guaranteed premium cost” insurance programs.