In an article published in the June 2019 issue of Captive Review, Laurie Bizzell discusses best practices for captive insurance companies as the Internal Revenue Service (IRS) focuses on aggressive examination and focus of captive insurance arrangements.
The IRS continues to warn taxpayers to avoid “abusive” micro-captive insurance arrangements. However, taxpayers should still utilize the non-tax benefits associated with a captive and understand how to utilize them as a cost-efficient risk management tool.
To remain in compliance with the IRS’ positions set forth in administrative rulings and the Tax Court’s decisions over the past few decades, captive owners and practitioners should focus on maximizing the risk management benefits and preparing for a potential IRS audit. Laurie unpacks the following 12 healthy tax practices for captives when establishing and managing a captive insurance company:
- Ensure the arrangement involves ‘insurance risk.’
- Ensure the arrangement provides for ‘risk shifting.’
- Ensure the arrangement provides the requisite ‘risk distribution.’
- Ensure the captive is operating as an insurance company in its ‘commonly accepted’ sense.
- Ensure arm’s length premiums are established according to customary industry rating formulas.
- Ensure insurance policies are appropriately executed in time and are legally binding.
- Ensure the parent does not provide any promises of the captive’s performance.
- Ensure all funds and records are kept separately and managed consistent with standards applicable to unrelated parties.
- Ensure formal policies are established for submitting claims for incurred losses and that claims are paid in compliance with the policies.
- Ensure the captive submits and pays for insured claims in a timely manner.
- Ensure the captive adheres to the minimum capitalization requirements but also has enough capital to cover the insured losses.
- Ensure the captive’s investments can provide for liquidity and produce income to fund losses.
“As a strategic risk management vehicle, captives should enhance or replace existing coverage and improve asset protection. A captive insurance company should also decrease insurance costs, including access to reinsurance coverage and excess cost. In light of the IRS’ current focus and scrutiny of micro-captives, captive owners and practitioners will want to perform a health check by reviewing their current or prospective captive insurance arrangements by taking into consideration the above checklist.”
You may view the full article here. Subscribers to Captive Review may read the full article in the publication’s June issue.