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The Varied Uses of Segregated Accounts Companies and Captives
June 29, 2010
Introductions
Speakers:
• P. Bruce Wright, Partner, Dewey LeBoeuf LLP
• Dennis Silvia, President, Cedar Consulting LLC
Moderator:
• Gavin P. Collery, President & COO, Alternative Group of Companies
22
Setting The Stage – Environment
• Soft Market
• Interest Rates
• Inflation
• Cash/Liquidity Issues
• Capital, Collateral, Credit Availability
• Below Average ROI
3
Setting The Stage – Captive Market
• Regulatory – Bermuda, U.S., E.U.
• Incorporations Continuing
• Economic Situation Driving Strategic Review And Uses
• Strategic Focus Being:– Identifying Untapped Potential Cost-saving
Mechanisms– Increasing Retentions– Accessing Excess Capital– Considering New Uses And Lines Of
Coverage
4
A Suggested Strategic Framework
• Construct Of A Risk Register
– Assets
– Liabilities
– Income
– Expenses
5
• Pure Captive
• Agency Captive
• Group Captive
• Segregated Cell
• Sponsored Cell Company
• Protected Cell Company– Protected Cell– Independently Incorporated Cell
• Segregated Account
Types Of Captives / Separate Accounts
6
• Principal Issues
– Characterization Of Transaction With The Captive / Cell
– Taxation Of The Income Generated In The Captive / Cell
Structural Considerations
7
Structural - Captives
• Isolate Insurance Assets And Liabilities By Individual Operating Units
• Customize Retention Levels And Insurance Terms And Conditions By Operating Unit
• Utilize Different Front Carriers By Line Of Business By Using Separate Segregated Accounts To Isolate Security To Front
8
Structural - SAC’s
• SAC Can Apply To Class 1, 2 And 3 Companies
• Required Special Reinsurance Acknowledgments In The Treaty
• Participation Agreement v. Preferred Shares
• Open v. Closed Cells
• Unlimited Number Of Cells
• Section 56 Direction For Reduced Capitalization
9
Structural – SAC 831(b)
• IRC Section 831(b) IRS Small Insurance Company Code
• Pending IRS Position
• Cost Effective Mechanism To Form Companies Under
10
Structural - Agency Captives
• Agency Takes Risk On The Client’s Business In Segregated Account With Consideration For Disclosure
• Offer Cost Effective Segregated Accounts To Agency Clients In Support Of Single Parent Captive Initiatives
• Offer Cost Effective Segregated Accounts To Agency Clients In Support Of Group Captive Initiatives
• Model For Other Service Providers Like Law Firms, Third Party Administrators, Front Companies
11
• Employee Benefits In A Cell
– SAME RULES AS CAPTIVE, I.E., Among Others . . .• Prohibited Transaction Exemption• Regulated By A Domestic Regulator
– Domestic Cell– Foreign Cell
» Branch» IRC § 953(d) Election
Possible Uses
12
• Group Captive For Small Participants
– Small Participants
– Group Arrangement Established In Advance
– Tax Issues Similar To Group Captive
– Securities Issues Similar To Group Captive
Possible Uses
13
• Industry Captive Center
– Single Industry With Small Participants
– Dedicated Cell Company
– Each Member Participated In A Separate Cell
– Reinsurance• Attaches At Each Cell• Cells Cede To Core Where Reinsurance Attaches
Possible Uses
14
• Industry Captive Center
– Allows For• Common Commercial Program For All With Common
Risk Management/Loss Control
• Individual Retentions At Working Layer
• Loses Some Benefit Of Deduction Analysis
Possible Uses
15
• Ancillary Program
– Captive Writing WC, GL, Auto Has Obtained Rating
– New Line Will Affect Rating Nov Capital/Reinsurance Proposal
– Keep Captive, And Maintain New Line In Cell
Possible Uses
16
Possible Uses
• Wealth Transfer
– Background• Assumption
– Insurance Transaction– Profitable Line Of Business
• Basis– Business Owned By Generation 1 Pays
Premium To Insurer– Insurer Is Owned By Generation 2/3 (Or
Trust For Their Benefit)
17
Possible Uses
• Wealth Transfer
– Background• Issues
– Application of IRC §§ 953(d) and 831(b) to Cell– If IRC § 831(b) Applies, Availability of Loss
Deduction– Capitalization of Cell
18
Decision Making Factors
• Understand the Capacity and Appetite to Assume More Risk
• Determine Future Expected Losses
• Gauge Market Response
• Consider the Total Cost of Risk
19
• Characterization Of Transaction
– Rev. Rul. 2008-8, 2008-1 C.B. 340• In General, A Determination Of Whether An
Arrangement Between A Person/Entity Paying "Premium" To The Cell Will Be Considered Insurance Is Based On Same Considerations As Those Taken Into Account With Respect To Captives
Tax Issues
20
• Characterization Of Transaction
– Rev. Rul. 2008-8, 2008-1 C.B. 340• Thus, All Rulings, Tams, Etc., RELATING TO
DEDUCTIONS APPLY, E.G., Rev. Rul. 2002-89, 2002-90, 2002-91, 2005-40, Etc.
• How Are Cells Which Are Not Insurers To Be Treated?– Separate– Roll Up Into Core
Tax Issues
21
• Characterization Of Transaction
– CCA 200849013• IRS In Viewing A Cell Aggregated All Divisions Paying
Premium Under Rev. Rul. 2005-40• Declined To Comment On The Necessity For
Homogeneity• Stated That Rules Under 2002-89 And 2005-40 Are
Applicable
Tax Issues
22
• Taxation Of The Income In The Cell
– Present Concerns Re: Taxation Of The Cell• Domestic/Foreign With IRC § 953(d) Election
– As Cell Is Not A Taxpayer, Return Must Be Prepared At The PCC Level
– Tax Sharing Agreement– Tax Must Be Contributed To PCC By Each Cell– Cell With Profit Must Compensate Cell With Loss
Tax Issues
23
• Taxation Of The Income In The Cell
– Present Concerns Re: Taxation Of The Cell• Foreign
– Cell Owner Who Cedes Business To Cell And Owns Preferred Stock Or Equivalent May Have To Include Subpart F Income
» Subpart F Includes Provision For Related Person Insurance Income (RPII) Unless• Less Than 20% Ownership RPII Shareholder • Less Than 20% Income Is RPII
Tax Issues
24
• Taxation Of The Income In The Cell
– Present Concerns Re: Taxation Of The Cell• Foreign
– Agency Cell Does Not Generate RPII– Potential For Passive Foreign Investment Company
(PFIC) Status– Potential For Taxation As Engaged In Trade Or
Business And Branch Profits Tax
Tax Issues
25
• Taxation Of The Income In The Cell– IRS Notice 2008-19, 2008-1 C.B. 366
• Proposed Treatment– In General Cell To Be Treated As A Captive Owned
By Cell "Owner"– Tax Elections Available By Reasons Of Cell's Status
As An Insurance Company Would Be Made By The Cell (Or In Certain Circumstances By The Parent Of The Consolidated Group And Not By Protected Cell Company
» IRC § 953(d)» IRC § 953(c)(3)(c)» IRC § 831(b)
Tax Issues
26
• Taxation Of The Income In The Cell– IRS Notice 2008-19, 2008-1 C.B. 366
• Proposed Treatment– Cell, If Subject To U.S. Tax, Would Need To Apply
For An EIN– Activities Of Cells Would Be Disregarded In
Determining Status Of PCC As An Insurance Company
» Note PCC Elections Under IRC § 953(d)» Note Cell Elections Under IRC § 953(d)» Engaged In A U.S. Trade Or Business» Status As An Insurance Company/Passive
Foreign Investment Company
Tax Issues
27
• Taxation Of The Income In The Cell
– IRS Notice 2008-19, 2008-1 C.B. 366• Proposed Treatment
– PCC Would Not Take Into Account Any Item Of Income, Deduction, Reserve Or Credit With Respect To A Cell
– Treatment Of Non-insurance Cell– Comments Requested (May, 2008)– Future (?)
Tax Issues
28
• Taxation Of The Income In The Cell
– IRS Notice 2008-15, 2008-1 C.B. 366• Transitional Rules
– Issues Relating To Untaxed Earnings And Profits– IRC § 953(d) Election
Tax Issues
29
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