ABA Insurance Companies Committee

1. ABA Insurance Companies Committee Captive Insurance: Back in the spotlight

2. US Treasury Circular 230 Disclosure Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

3. What is a Captive? • Definition – • A captive is an insurance company that belongs to a corporation or group and underwrites or reinsures primarily or exclusively the risks of firms belonging to that group. It can also underwrite unrelated business. • It is also often: • A risk retention device • A vehicle for achieving an organization’s insurance, finance and management goals • Owned by shareholders whose primary business is not insurance • A direct insurer or a reinsurer • Tax efficient Note – Over 50% of the Fortune 1,500 have a captive

4. Captive Formation Reasons, and roadblocks Don’t try to read them all!!! Capital Commitment Provide flexibility Improved cash flow benefits Provide evidence of insurance State and local tax advantages Analyze historical claim information Ability to customize insurance programs Direct access to the reinsurance markets Opportunities for improved claim handling Reduction of the cost of risk management Provision of coverage otherwise unavailable We will have the ability to control our destiny We know our risks better than any underwriter Provide management information across disciplines Stabilization of pricing and risk management portfolio Have an independent actuarial review of claim history Federal tax advantages over large deductible programs Create a potential profit center from a business expense We do not want to be rated based on others and industry losses Formalize the allocation of deductibles for self-insurance retention within a corporation Off the shelf insurance programs do not always suit our company’s strategy or circumstances Reduce reliance on commercial insurance – less vulnerable to price fluctuations and market restrictions. TAX! Administrative Duties Closure and Run-off

5. Types of Captives • Pure/single parent captives • Rent-a-captive • Association captives • Group captives • Risk retention group (RRGs) • Agency • Cell captives • 831(b) – small captives

6. Types of Risk Typically Insured • General liability • Property • Worker’s compensation • Product liability • Auto • Medical malpractice • Environmental • Professional • Health

7. Domiciles Summary* * Business Insurance 2013 Market Insights – Crain Communications

8. Largest Domiciles Times are changing… => 10 years ago, Guernsey and Utah only had a handful of captives!

9. Captive Growth Continues * Business Insurance 2013 Market Insights – Crain Communications

10. Largest Captive Managers

11. “In The News” • Federal Issues • Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 - applicable to captives? • Tax issues • State self procurement tax changes, FATCA issues • International Issues • The European Union Solvency II Directive, (January 1, 2014), - may increased capital requirements 300% • Looking Ahead • Legislation introduced in Congress to amend the Liability Risk Retention Act of 1986 proposes to permit risk retention groups to cover property insurance.

12. Tax Issues Facing Captive Insurance Companies • Risk Shifting/Risk Distribution • Number of Insureds and Introduction of Third-Party Risk • Pooling of Risk • Establishment of “Micro Captives” under Section 831(b)

13. Pending Cases Addressing Captives • U.S. Tax Court • Rent-A-Center, Inc. & Affiliated Subs. (Dkt. Nos. 8320-09, 6909-10 & 21627-10) • YRC Worldwide & Subs. (Dkt No. 6714-10) • Securitas Holdings, Inc. & Subs. (Dkt. No. 21206-10) • Dielco Crane Service (Dkt. No. 21726-10) • Pilgrim’s Pride (Dkt. No. 16972-10) • Vincent Enterprises, Inc. & Subs. (Dkt. No. 2759-10)

14. Pending Cases Addressing Captives • Court of Federal Claims • Proliance Surgeons (Dkt. No. 1:09-cv680) • U.S. District Court (N.D. Texas) (Cases are consolidated.) • Salty Brine (Dkt. No. 5:10-CV-00108-C) • K&T Farm Ltd. (Dkt. No. 5:10-CV-00109-C) • Wasson Solid Waste Disposal System (Dkt. No. 5:10-CV-00110-C) • Five Star Consolidated Companies (Dkt. No. 5:10-CV-00111-C) • Thomas & Kidd Oil Production (Dkt. No. 5:10-CV-00141-C)

15. “Micro Captives” under Section 831(b) • Insurance companies with less than $1.2 million of premiums written may elect to be taxed on “net investment income” • Election is irrevocable with out IRS consent • May not use net operating losses to offset income, or to carryforward/carryback from a loss year • Consolidated return/basis differences impact unclear

16. Implications of State Self-Procurment Taxes and Dodd-Frank Legislation

17. State Tax on the Purchase of Insurance • 1. Purchase a policy from an insurer authorized to write in the state. • Authorized insurer – an insurance company licensed with that state’s insurance department (e.g., GEICO, State Farm, Nationwide, Progressive, etc). • Authorized can include an insurance company licensed as a captive in that state. • States impose a premium tax on authorized insurers. • Premiums Written x 2% (average tax rate) • Premium tax cost is built into pricing for the policy. • Insured pays no direct tax to the state.

18. State Tax on the Purchase of Insurance • Three Ways to Purchase – Three Ways to Tax • Purchase a policy from an insurer authorized to write in the state. • Authorized insurer pays a premium tax to the state. • Purchase a policy using an authorized broker, from an insurer not authorized in the state. • Broker collects tax from the insured and pays it to the state. • Purchase a policy from a company not licensed in the state. • Insured pays the tax to the state.

19. State Tax on the Purchase of Insurance • 2. Purchase a policy using an authorized broker. • Specialized risk – workers’ compensation, professional liability, etc., not offered by insurers licensed in the state. • Excess insurance – covers liability above a stated amount. • Surplus Lines – not subject to state rates and forms. • Insured deals with a broker authorized with the state to place the specialized insurance with an unauthorized/nonlicensed insurer. • The broker collects the tax from the insured and pays it over to the state.

20. State Tax on the Purchase of Insurance • 3. Purchase an insurance policy directly from an insurance company not licensed in the state. • Specialized risk – workers’ compensation, professional liability, etc., not offered by insurers licensed in the state. • Insured contacts the unauthorized insurance company (could be a captive not licensed in the state or in the United States) directly to place the insurance. • The state requires the insured to pay a flat premium tax on the premiums paid to the unauthorized insurance company. • Rates range from 1% to 6% of premium. • 38 states imposed this type of tax.

21. State Tax on the Purchase of Insurance • The Nonadmitted Reinsurance Reform Act (NRRA) • The only tax provision included in Dodd-Frank. • Purpose was to make uniform and simplify the payment of taxes on excess and surplus lines insurance. • Make placement of such insurance easier. • Special risk insurance. • Previous law could subject > 100% of premiums to state tax. • Only the “home state” of the insured can impose the tax. • Home state – headquarters or principal place of business. • Tax imposed on 100% of the premiums. • Taxes premium on risk not located in the home state. • States to share tax revenue with other states where risk is located.

22. State Tax on the Purchase of Insurance • Captive Insurance – Does the Tax Apply? • Vermont Captive Insurance Association Whitepaper. • The definition of “unauthorized insurance” by the National Association of Insurance Commissioners (NAIC) does not include insurance purchased from a captive. • Federal Legislators • Several who worked to pass NRRA say it should not apply. • States see it as a source of revenue. • New York, Pennsylvania, Wyoming.

23. State Tax on the Purchase of Insurance • State Procurement Tax Rate State Procurement Tax Rate State Procurement Tax Rate • Alabama 4.00% Kentucky 2.00% North Dakota • Alaska 3.00% Louisiana 5.00% Ohio 5.00% • Arizona 3.00% Maine 3.00% Oklahoma 6.00% • Arkansas 2.00% Maryland 3.00% Oregon • California 3.00% Massachusetts Pennsylvania 3.00% • Colorado 3.00% Michigan 2.00% + 0,5% Reg. Fee Rhode Island 4.00% • Connecticut 4.00% Minnesota 2.00% South Carolina • Delaware Mississippi 3.00% South Dakota 2.50% • District of Columbia Missouri 5.00% Tennessee • Florida 5% plus.3% service fee Montana 2.75% Texas 4.85% • Georgia 4.00% Nebraska Utah 4.25% • Hawaii 4.68% Nevada 3.50% Vermont 3.00% • Idaho 1.50% New Hampshire 4.00% Virginia • Illinois New Jersey 5.00% Washington • Indiana New Mexico 3.00% West Virginia • Iowa New York 3.60% Wisconsin 3.00% • Kansas North Carolina 5.00% Wyoming 3.00%

24. Questions