Captive Solutions

So-called captive insurance is nothing new, inside or outside of trucking, but not all fleets are aware of the cost-control impact dedicated programs can have, nor of all the forms they now take.

A fleet that purchases traditional commercial insurance pays premiums to an insurer for coverage of its risks. A fleet that is self-insured retains its risks and pays claims or losses from “captive,” or on-balance-sheet funds with the aim to cut overall costs by avoiding the costs of doing business passed on by insurance firms to customers.

Captives got a serious boost back in 2001 when the Internal Revenue Service announced it would no longer invoke the “economic family theory” to challenge the tax deductibility of premiums paid by companies for captive insurance. As a result, according to insurance giant Liberty Mutual, “the federal taxation environment for companies forming captives became far more favorable.”

The national law firm Nelson Mullins Riley & Scarborough LLP, defines a captive as “an entity formed to provide insurance coverage to its owners,” including commercial vehicle liability risks for trucking companies. “A captive may also be used as the insuring vehicle to a risk-retention group, generally an entity formed to provide liability insurance to members.”

Nelson Mullins, which has been involved in nearly 40 captives since 2001, contends that setting up a captive insurance operation can provide these benefits to owners:

VIABLE ALTERNATIVE

Obtaining coverage otherwise unavailable or unaffordable
Opportunity to participate in underwriting, pricing and other insurance management decisions
PURE AND MORE

Ability to stabilize insurance prices based on the loss experience of a small number of insureds
Access to the reinsurance market, resulting in a lower cost for reinsurance
Ability to invest certain assets of the captive, which may result in additional funds to pay losses and lower premiums for policyholders
Ability to obtain return on investments made into the entity in the form of dividends or other distributions.

SERVICE PARTNERS

The law firm states that captive insurance “may be a viable alternative to traditional insurance if a client can provide the initial required capital and surplus (generally between $250,000 and $1 million, depending on the type of captive entity formed); would be able to pay premiums to the captive to cover the expenses of the captive and would provide some savings to the client in reduced premiums; and can project a sufficiently low loss experience such that the captive would be expected to build surplus over time and thereby enhance its ability to pay losses.”

Like commercial insurers, captive insurance companies are licensed and regulated by state insurance department officials. They can be set up in a number of ways, which is where attorneys and other specialists come into the picture — at least to ensure the operations are established and governed correctly.

Nelson Mullins points out that the most straightforward example is the “pure” captive structure. The firm describes this as “a captive insurance company that is typically owned by one or just a handful of owners and which provides insurance to its owners. A pure captive can be formed as a business corporation, a nonprofit corporation or a limited liability company, depending on the domicile in which the captive is formed.”

From there, things can get more complicated as captives can take several different forms (see box). For example, a group of fleets may pool their risks under a single captive operation they collectively own, manage and benefit from. These may be referred to as “risk retention groups,” which Nelson Mullins defines as not captives themselves, but operations that use captives as insuring vehicles “formed by a group of individuals or entities that have similar liability risks by virtue of a common trade or business.”

Nelson Mullins recommends first hiring an actuarial firm to conduct a feasibility study to determine if captive insurance is even the right approach for a given fleet. Such a study can show whether a business can “provide and maintain the initial required capital and surplus (generally between $250,000 and $1-million) and pay premiums to the captive in an amount that will cover expenses.”

The law firm cautions that how a captive is designed depends on a number if factors, including number and location of the captive's owners and the locations in which the captive will write coverage. Legal and tax advisors, as well as insurance professionals, should be consulted along the way.

However, as with most other things today, you can have your captive and have someone else do all the work for you. That is, an outside firm can be hired to set up and/or manage a captive.

According to Peter Willitts, president of Liberty Mutual Management Services, choosing the right captive service partner in essence means selecting from two suites of services, which can be provided separately or bundled.

SPECIALISTS

“The first suite, provided by captive managers, includes core financial, regulatory compliance and internal control services,” Willitts states. “The second suite of services, provided by what is called fronting companies, includes policy issuing, underwriting, claims handling and loss prevention services. These services relieve the captive's parent from the day-to-day administrative responsibilities associated with running an insurance company.”

If a captive is determined to be the way to go, another key step is deciding in which state to form and license it. At least 22 states and the District of Columbia now have captive laws on the books. Some states — notably Vermont and South Carolina — are particularly aggressive about seeking this business.

Another wrinkle to be aware of is the silly sounding rent-a-captive. According to FM Global, an international commercial insurance and risk management firm, a rent-a-captive is a “captive insurance company formed by third-party investor(s) and operated as an income-producing venture for the renters (companies who participate as insureds). Companies wishing to utilize (“rent”) the captive pay a fee and/or invest in the captive. The rent-a-captive insures the risks of its renters and returns underwriting profit and investment income to them.”

Liberty Mutual established what it calls an “on-shore rent-a-captive insurance facility” two years ago in Vermont, called Liberty Sponsored Insurance (Vermont), Inc. (LSIV).

Liberty Mutual's Willitts says the Vermont operation expanded the captive marketplace in the U.S. by giving buyers “access to a well-respected, Fortune 116 company” offering a full suite of products. “Vermont protects our participants' assets with laws similar to those in Bermuda which maintain the legal segregation of assets within the sponsored captive,” notes Willitts,

While major firms like Liberty Mutual and FM Global are well engaged in providing captive solutions, fleets may also turn to law firms such as Nelson Mullins or to specialized providers like Intuitive Captive Solutions, which was formed by Intuitive Insurance Corp., a commercial property casualty insurance agency.

Intuitive Captive has gone after the captive market by launching a trademarked operation, CapPlus, it describes as “a privately held domestic insurance company licensed to sell custom designed property and casualty insurance products to your operating company.”

THANKS, IRS

According to Intuitive Captive managing partner Jim Landis, generally speaking a company that has $1-million to $2-million of net income qualifies to set up a captive, but he says other considerations include the types of business risks, existing coverage and the availability of free cash flow.

Landis says it has only been over the past three years that single-parent captives — one fleet is the captive's owner — have become viable for “middle market, closely held businesses, including trucking operations.”

“We customize the single-parent captive to fit the needs of the business and annually act as the turn-key manager, providing annual audited financials, tax returns, actuarial updates and other regulatory filings,” he explains.

Landis says a single-parent captive should be seen as a “risk management tool designed not to replace a third-party insurance but to supplement it.

“We identify the self-insured risks a company has that are not covered by third-party insurance — deductibles, exclusions, such as haz-mat, losses in excess of limits, and unexpected risks, such as wind damage.

Captive calculations

“The idea,” he continues, “is to take those uninsured risks and put them under a new captive firm you own, that you created with an off-balance sheet reserve to protect you against those risks. By controlling both the risk assumed and the claims paid, you can eliminate any doubt as to what or how coverage applies — and ensure claims in the operating company are fully reimbursed.”

Landis also points out that under Section 831(b) of the Internal Revenue code, other tax and financial benefits of captives come into play.

FOR MORE INFO.....

“Premiums paid by the operating company to the captive are treated as a tax deductible expense. That reduces the tax liability of the operating company and its owners. Over time, as the captive accumulates cash from the premiums and investment income, a portion of the cash can be loaned back to the operating company at market rates with proper documentation.”

According to Landis, the key thing to bear in mind is using a single-parent solution like CapPlus “allows a middle-market operation to control their own risks without being involved with other firms — and at the same time, they can gain tax benefits and fund a reserve against any future [insurance] losses.”

He does note that group captives also have their place in the market, but says they “present a different risk/reward proposition” that may not fit the needs of many mid-sized trucking firms.

Captive insurance is not new, inside or outside trucking. But changes in the tax code coupled with the reluctance of many insurance firms to write trucking coverage directly and the desire of all fleets to save money has given rise to new innovations that are worth looking into by many — if not all — fleets.

As seen in these descriptions of captive solutions drawn from a State of Vermont website, captive insurance may be a cost-effective but not necessarily a simple solution:

Single-owner captive, also referred to as a “pure” captive, insures only the risks of the owner or the owner's subsidiary operations
Group captive is owned by multiple, non-related organizations and is designed to insure the risks of these different entities.
Risk retention group (RRG) is an entity created under the federal Liability Risk Retention Act and licensed in any one state to write liability insurance; is regulated as a captive insurance company; and may operate nationwide, provided it properly registers with each state in which it proposes to solicit or write insurance
Association captive is owned by members of a common industry or trade association in order to share the risks of that industry among its members
Reciprocal captive is an unincorporated association; reciprocal insurance is that which results from an interchange among subscribers of reciprocal agreements of indemnity, the interchange being effectuated through an attorney-in-fact common to all subscribers
Association captive is owned by members of a common industry or trade association in order to share the risks of that industry among its members
Sponsored captive is one that uses the capital provided by an insurer or reinsurerr while providing “fronted” insurance coverage to discrete and usually unrelated entities. The sponsored captive [in Vermont] can be either a licensed insurer, an authorized reinsurer, or a fronted Vermont captive insurer (except RRG)
Branch captive [in Vermont] is a unit of an existing offshore (“alien”) captive, licensed in Vermont to write employee benefit business for its owners and affiliates onshore. The branch is regulated as a pure captive, is taxed only on the branch writings and is required to use an onshore trust for the protection of U.S. policyholders and ceding insurers.