presentation - employee benefit captives (4-17-15 - final ... · employee benefit issues: how...

4/27/2015

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#ACIInsurance

ACI's3rd AdvancedForumonCaptiveInsurance

StevenBaumanHeadofCaptiveServicesZurich

Employee Benefit Issues: How Captives Are Used to Insure Employee BenefitsHow the IRS Views Medical Stop LossHow Feasible of an Option Medical Stop Loss is for Small and Middle Market

PeterJ.BandarenkoHeadofNewMarketDevelopment/Sr.ConsultantSpringConsultingGroup,LLC

April 23‐24, 2015

BrianT.CaseyPartner,Co‐ChairofRegulatory&TransactionalInsurancePracticeGroupLockeLordLLP

WilliamR.PaulsPartner,TaxGroupSutherlandAsbill&BrennanLLP

Tweetingaboutthisconference?

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Today'sAgenda• Why Fund Employee Benefits in a Captive?

• Medical Stop Loss Considerations

• Multinational Benefits in Captives

• ERISA Benefits in a Captive—How To Gain DoL Approval To Do It

• U.S. Federal Income Tax Considerations Associated with Employee Benefit Captives

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WhyFundEmployeeBenefitsinCaptives?

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Overview• Faced with escalating costs, many organizations are now considering funding employee benefits through a captive

• The process has been streamlined• Obtaining DoL approval for ERISA based benefits is moving back to Fast‐Track programs because of Coca‐Cola and Intel

• The DoL regulatory assistance is more systemized

• Significant funding of non‐ERISA benefits is occurring (stop loss, etc.)

• Emerging benefits turnkey structures

• Certain employee benefit coverage can be viewed as "unrelated business"• Adding unrelated business to an existing P&C captive could improve the captive's overall financial efficiency and create additional savings

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1960s/ 1970s Big Corporates;Mono‐line Property & Casualty.

2000s Employee Benefits joins P&C coverages. Cell Structures.

2014 & Beyond: Integrated Multi‐line, Enterprise Risks.

2010 Opportunity: Captive as a Profit Center. Captives for everyone.

ASound‐BiteHistoryofCaptives

1980s/1990s Globalization, XS Casualty, 3rd party business.

Captives Thinking

Outside the Box

Pre 1960 Captives

Post 2014 6,000 +

captives ?

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• Captive utilization is a risk management philosophy.

• A risk management infrastructure

• Captives are: • Long‐term endeavor.

• Very relationship oriented.

• Used in nearly every line of coverage.

• Used everywhere in the world.

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CaptiveUsesforCorporateClients

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CaptiveUsesforBenefits• New captive formations and expansion of existing captives• Expanded cell captive use

• Greater domicile choice

• Increased funding of unrelated / 3rd party risk • Truly unrelated

• Employee benefits

• Focus on post‐retirement costs in Europe and US are becoming critical issues where captives are a solution• Pensions

• Retiree medical

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BenefitsCaptiveAdvantagesManage Costs

• Accelerate cash flow through premiums, claims and reserves • Reduce frictional costs (commissions, taxes, risk charges, administration)

• Capture underwriting savings and investment return• Improve cash flow and centralize investment of reserves

Improve Risk Management

•Operate and manage a central risk pool

•Implement appropriate stop loss reinsurance to manage peak risks

•Reduce overall cost of risk

•Manage retention levels to corporate objectives

•Aggregate international risk pools – increase geographical spread of risk

•Implement appropriate reinsurance to manage peak risks

•Minimize transactional costs

•Design structure to incentivize behaviors that lead to lower costs

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Support Employee Retention

• Cost effective funding of program benefits

• Custom design benefits to meet employee and employer needs

• Employee participation (DoL approval may be needed)

Support P&C in a Captive

• Enhance coverage spread of risk

• Create "unrelated" business – potential efficiency

• Increase reserves and reduce dependence on external markets

Increase Control

• Design coverage and provisions of benefits

• Improve data management and claim cost management

• Remove insurer's profit loading

• Improve management reporting and understanding of risks9

BenefitsCaptiveAdvantages

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EmployeeBenefitsInCaptives

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Life Disability Accident & Health Medical (StopLoss)

Retiree Medical Foreign EB

9%8%

6%

13%

8%

8%

5%5%

9%

5%

12%17%

15%

19%

6.4%

8%

Already in Captive Likely in next 3 Years Possibly in next 3 Years

Pure Captives

2014 (March). CICA International Conference "Captives Global Opportunities & Solutions."

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EmployeeBenefitsInCaptives

0%

5%

10%

15%

20%

25%

30%

35%

Life Disability Accident & Health Medical (StopLoss)

Retiree Medical Foreign EB

8%4%

4%6%

6%13%

13%

21%

17%

11.5%

6%

Already in Captive Likely in next 3 Years Possibly in next 3 Years

Group / Cell / Association Captives

2014 (March). CICA International Conference "Captives Global Opportunities & Solutions."

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U.S.EmployeeBenefitOfferings

Retirement Health Security Time Off

Voluntary

VacationFinancialProductsHolidaySTD1Drugs

DefinedContribution

Sick Leave

Mortgages

Investment Funds

Fringe

Training, Education Assistance

Transportation

FSA3

Legal, Financial Planning

Dental

Other Leave

Health & Welfare

Pension

Post‐Ret Life

Post‐Ret Medical

Medical

Life Ins.

LTD2

Workers' Compensation

Auto / homeowners Insurance

LifeLong Term

Care

1 Short Term Disability2 Long Term Disability3 Flexible Spending Accounts4 Employee Assistance Programs (mental health, legal assistance, etc.)

Multinational Pooling, Expatriate Global Assistance

Prevention, Disease Mgmt

Critical Illness

EAP 4,

Work/Life

Executive Benefits

Typical Non‐ERISA

Typical ERISA Plans

= Typical Captive Programs

Stop Loss

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EmployeeBenefitCostSavingsUsingCaptives

Program Estimated Savings* Frictional Costs

Term life insurance 10% ‐ 15% Commercial insurance

Retiree medical 3% ‐ 15% Accumulated Post‐Retirement Benefit Obligation

Long‐term disability 15% ‐ 25%

Commercial insurance

On self‐insurance, accelerated deduction of claims cost and tax effective investment accumulation on reserves

Multinational pooling 10% ‐ 15% Commercial insurance

Active medical stop loss 10% ‐ 12% Cost of stop loss

Executive benefits

Deferred compensation

COLI

Split dollar replacement

10 + % Net cost resulting in higher yield on investments

* These are typical savings that our clients have experienced in the past; actual performance may vary

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BenefitCaptivesHaveComeaLongWay

Captives were not common for benefits financing:

• Companies often perceived obstacles (e.g., reinsurance restrictions)

• Territorial restrictions (i.e., U.S. only)

• Relatively few employee benefits reinsured by captives

Limited HR familiarity with captives

Insurer reluctance

Alleged marginal economics

More people involved:

• HR, Finance and Risk agendas

• Everyone knows about it Enterprise risk financing Network restructuring and changes not

aligned with growing market Companies looking at captive solutions

as the next step in cost savings and control

What does this mean?Companies need a clearly defined strategy around the risk financing of its benefits programs

Ten Years Ago Now

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MedicalStopLossConsiderations

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WhatIsMedicalStopLossInsurance?• Used by self‐insured employers

• Not a “Health Insurance Policy”

• Written as health or casualty line of insurance dependingon state insurance law’s classification

• Employees are not a party to the contract, which is usuallya contract between insurer and employer, not employer’sERISA plan

• Insurer indemnifies employer for health benefits claimsunder employers’ ERISA plan

• State mandated health insurance benefits do not apply

• Federal law does not regulate stop‐loss insurance, assumingno Multi‐Employer Welfare Arrangement (MEWA) 16

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ERISAandStopLossInsurance

• ERISA does not preempt state regulation of stop‐lossinsurance

• States may regulate insurance policies issued toplans or plan sponsors, including stop‐loss insurancepolicies, if the law regulates the insurance companyand the business of insurance

• American Medical Security, Inc. v. Bartlett, 111 F.3d 358(4th Cir. 1997)

• Department of Labor Technical Release No. 2014‐01 (Nov.2014)

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NAICModelStopLossInsuranceAct• Developed to limit stop‐loss insurance policies with lowattachment points functionally acting like health insurancepolicies, but avoiding state mandated health benefits

• Prohibits insurers from issuing stop‐loss insurance policythat has:

• Individual annual per claim incurred attachment point less than$20,000

• Annual aggregate claims incurred attachment point:

• Small employers (50 or fewer employees) ‐ less than greater of (1)$20,000, (2) $4,000 times number of employees or (3) 120% annualexpected claims

• Larger employers (51 or more employees) ‐ less than 110% of annualexpected claims

• Direct coverage of health care expenses of an individual18

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NAICModelStopLossInsuranceAct• NAIC sought in 2012 to increase attachment points for smallemployers to $60,000 per employee and $15,000 peremployee in aggregate, but it never passed out of Committee

• Very few states have adopted either the earlier version of themodel law or the updated version in its entirety; although anumber of states regulate stop loss insurance either throughexplicit regulation or “desk drawer” rules.

• DE, NY, and OR prohibit stop‐loss insurance to small groups(50 employees in OR and NY, and 15 in DE)

• NC applies underwriting, rating and other small group healthinsurance requirements to stop‐loss insurance issued in thesmall group market

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PPACAandStopLoss• What does PPACA say about stop‐loss insurance?

• Nothing

• Stop‐loss insurance coexists with PPACA for both large and smallself‐insured employers

• Health insurer fee and reinsurance, risk corridor and riskadjustment programs do not apply to stop‐loss insurance

• Small employers offering coverage cannot impose annual orlifetime benefit limits; stop‐loss effectively required

• May 1, 2012 Federal Information Request

• IRS, EBSA and CMS issued a request for information regarding useof stop‐loss insurance, with eye on potential future regulation

• Focus was on low attachment points

• To date nothing has come of this information request20

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PatientProtectionandAffordableCareAct– EmployerMandateBasics

• Large Employers – 50 or more FTE Employees

• Must offer “Minimum Essential Coverage” or pay penalty if 1 employee buyshealth insurance on a health insurance exchange and receives federal subsidybecause employee’s income is between 100%‐400% of federal poverty level

• If “Minimum Essential Coverage” offered, but employee’s contribution exceeds9.5% of employee’s gross income, employer pays penalty as coverage deemedunaffordable

• Spouses are not dependents, but children under 26 are

• ERISA employee welfare benefit plan

• Buys group health insurance policy to fund ERISA benefits

• Self‐insures ERISA benefits with or without medical stop‐loss insurance

• Effective Dates of large employer mandate

• January 1, 2015 if 100 or more employees

• January 1, 2016 if 50 to 99 employees 21

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PatientProtectionandAffordableCareAct– EmployerMandateBasics• Small Employers – 1 to 49 FTE employees

• No health insurance mandate/penalty for smallemployers

• Small employers offering essential health benefitsreceive tax credit subsidies

• Small Health Options Program (SHOP) Exchangeopened in 2015 required to offer “Essential HealthBenefits”

• Small employer market is most prone to use ofmedical stop‐loss insurance

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PPACA'sSmallEmployerSelf‐InuredConcerns

• Adverse selection impact on the Small HealthOptions Plan (SHOP) exchange• Small employers with healthy employee populationswould self‐insure, driving small employers with unhealthyemployee populations to buy SHOP offered healthinsurance

• Examples of employee groups that seek touse stop‐loss insurance because of PPACA• Labor Unions

• Professional Employer Organizations (PEO) 23

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PatientProtectionandAffordableCareAct–TreatmentofLaborUnions

• Most unionized employees have had employer‐paid healthbenefits negotiated in collective bargaining agreements

• Individual employer provided

• Multi‐employer provided via welfare trusts, Taft‐Hartley(TH) Plans

• Unions are neither employers nor insurers and largely leftout of PPACA, but individual mandate can be satisfied viamulti‐employer plans meeting minimum essentialcoverage

• IRC §4980H transition rule for 2014 allowed largeemployers contributing to multi‐employer plans to avoidemployer mandate penalty

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PatientProtectionandAffordableCareAct–TreatmentofPEOs• Before PPACA, PEO treated as co‐employer forpurposes of both health insurance and workers’compensation laws

• After PPACA, PEO is not treated as employer forpurpose of health benefits

• Effectively shut down PEO’s ability to provide healthinsurance to larger employer customers

• Presents Multi‐Employer Welfare Arrangement(MEWA) challenges for aggregating health insurancerisks of small employer customers 25

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CaptiveStopLossInsurance• Generally, most state captive insurance laws permit captiveinsurers to issue stop‐loss insurance

• Limited in states like DE, NY and OR that prohibit stop‐lossinsurance generally

• Employers with principal place of business or other significantbusiness office outside of these states should be able to buy stop‐loss insurance even though they have employees located in thesestates

• Do state stop‐loss insurance minimum attachment pointsapply to captive stop‐loss insurance?

• If NRRA, or state law (see IL), makes a captive insurer asurplus lines insurer, is stop‐loss insurance a prohibited lineof insurance, especially in those states where it isconsidered a line of health insurance?

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StopLoss=NoDoLApproval

• Generally if an employer wants to insure employeebenefits through a captive, an entity must obtainapproval from the Federal Department of Labor

• This was previously a very tedious process• Fast‐Track approval has returned with DoL approval of captivebenefits funding applications for Intel and Coca‐Cola

• However, still a very time‐consuming (nearly three months onaverage) and costly process

• Stop‐loss policies issued by a captive are usually notsubject to DoL approval – See DoL Advisory Opinion92‐02A 27

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SamplePEOCaptiveBermudaStopLossTransaction

28Reinsurance Company

Professional Employer Organization

(PEO)

PEOEmployer Customer



Voluntary Employee Benefit

Association(VEBA)


Association(VEBA)


Association(VEBA)

Medical Stop‐Loss Insurance Policy

BermudaPurchasing

Trust

Bermuda CaptiveInsurer

Reinsurance Agreement

PEOPEO

Employer Customers

$ Premiums

Claims $

Trust

Contrib

utio

ns

Claim

s $

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MedicalStopLossGrowth• According to a recent CICA survey captive utilization for medical stop loss is likely to show double digit growth over the next three years

• More turnkey solutions

• Typically not ERISA plans (DoL Advisory Opinion 92‐02A)

Medical Stop Loss growth

Already in captive

Likely in 3 years

Possibly in 3 years

13%

9%

19%

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WhatIsDrivingInterestinStopLossCaptives?• Natural to extend existing Property and Casualty (P&C) captives to include accident and health coverage

• Potential improvement of efficiency for existing captives

• Multiple Employer Welfare Arrangement (MEWAs) and other group stop loss structures are prohibited or require more capitalization

• Heterogeneous entities can pool coverage

• Coverage funded in a cost effective manner

• Stop loss is priced conservatively

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PPACAImpactonHealthInsurancePrograms

• Self funding will result in the plan saving on the taxes below

Health Insurance Tax (HIT)

Begins in 2014Fee on all insured plansIncludes dental/vision2%‐2.5% initially3%‐4% of premium increasing in future yearsPermanentInsured: Built inASO: Not applicable

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GroupCaptiveHealthInsuranceRiskStructure

Reinsurer (excess of 125% of expected Captive claims)

Captive (excess of 125% of member expected SIR)

Member SIR (e.g. $150k per member, up to 125% of expected)

Captive(e.g. Next $350k per member)

Reinsurer (Excess

$500k per member)

SPECIFIC RISK

AGGREG

ATE RISK

Captive stop loss saves 5% to 15%

Each member is

individually underwritten

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MultinationalBenefitsinCaptives

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Single‐ParentCaptiveProgram

Reinsurance Captive

(Owned by Customers)

Retrocessionaire(s)(Reinsurance Market)

FrontingInsurer Zurich

Insurance

Dividends Payments

Reinsurance & Collateral

Retrocession

Capitalization

ClaimsCorporate Customer(Insured)

International and domestic policies

Non‐Life International Program

Life Employee Benefits pooled En

d‐to

‐End Insuran

ce / Rein

suran

ce

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TypicalNetworkStructureExample:TransferofRiskandPremium

Subsidiary SubsidiarySubsidiary

Global Network Partner (Reinsurer)

Local Insurer Network Partner

Premiums Claims Premiums ClaimsPremiums Claims



Quarterly Claims Reimbursement

Net Premium

Home Office

SingaporeUnited KingdomFrance

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MultinationalPoolingWithout Multinational Pooling

Claims

Commission, Taxes

Expenses and Risk/Profit

With Multinational Pooling

Claims

Commission, Taxes

Expenses and Risk/Profit

International Profit Sharing

…returned to the Client and/or the Captive

Programs Typically Considered for Inclusion:Group Life InsuranceDisability InsuranceAccidentHealth Insurance

Pension Medical Stop Loss Expats

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NetworkStructureExample:CaptiveTransferofRiskandPremium

Subsidiary

Global Network Partner (Reinsurer)

Captive (Retrocessionaire)

Local Insurer

Network Partner

Premiums Claims

Quarterly Claims Reimbursement

Annual Net PremiumQuarterly Claims Reimbursement

Net Premium

Home Office

SingaporeUnited KingdomFrance

Reinsurer

Subsidiary Subsidiary

PremiumsPremiums Claims Claims

Local Insurer

Network Partner

Local Insurer

Network Partner

Captive is potentially final risk taker

Reinsurers 100 % less ceding commission

100 % Ceded Less ceding commission

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TypesofMultinationalCaptivePrograms• Passive Agreement

• Captive is contract holder for the pooling contract

• Captive receives the multinational dividend

• Captive Risk Retention

• Certain level of risk charges and risk in the pool

• Directly writes up to 100% of the loss below a retention level or reinsure to cap the loss at a specific dollar amount

• Retains the underwriting profit

• Treaty Reinsurance

• Partners with an insurance carrier

• Responsible for claims payment and additional administrative tasks

• Retains the risk charge, taking premiums, risk and reserves, and transfers them back to the captive which may include a large deductible structure ‐ improves cash flow

Can enter into an arrangement with and without reinsurance as a percentage (%) above the expected claim level and with

catastrophic reinsurance with multiple event triggers

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ERISABenefitsinaCaptive—HowToGainDoLApprovalToDoIt

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WhyIstheDepartmentofLaborInvolved?• Companies interested in funding employee benefits in a related insurance company may constitute a prohibited transaction between a party in interest (the captive) and the plan

• ERISA describes a party in interest (ERISA §406) for captive insurance companies• Employers are "parties in interest" if 50% or more of the captive's premiums are related to the parent

• Direct or indirect furnishing of services between a plan and "party in interest" is prohibited unless you receive a DoL exemption

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DoL'sPositiononFundingEmployeeBenefitsThroughCaptives

• The DoL permits exemptions to prohibited transactions

• Statutory exemption – 5% exemption for commercial insurers who insure own benefits

• No DoL approval required

• Class exemptions – applies to broad range of transactions

• Prohibited Transaction Exemption (PTE 79‐41) – 50% of the captive's business must be with parties unrelated to the employer

• If a captive satisfies this 50% test, the captive can be used to fund directly written employee benefits without the DoL's approval

• Individual exemptions – applies to particular applicant's case and requires DoL review and approval

• Prior to 2012, exemption applications could qualify for the DoL's EXPRO process, also known as "fast track"

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WhatIsEXPRO?• PTE 96‐62 allowed applicants, to apply for an expedited process so long as they could point to either:• 2 substantially similar transactions subject to individual exemptions within a 5 year period, or

• 1 substantially similar individual exemption within 10 years and one substantially similar transaction authorized via EXPRO within 5 years

• Under EXPRO, the approval process took about 78 days or half the time it would take an individual exemption to be approved

• With its shorter turnaround time, EXPRO became a popular process and most of the ERISA applications followed this process

Not all benefits captive transactions are subject to DoL approval

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EXPROUnderReview• In 2012, the DoL announced that it would be reviewing the EXPRO criteria and that going forward, applicants would need to follow the individual exemption process

• The review coincided with the sunsetting of the base exemptions used to fulfill the "substantially similar" exemption requirement

• As a result of the review, the number of PTE applications decreased until two new cases – Coca‐Cola and Intel –came forward

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WhatIstheDoLFocusedOn?• In addition to pointing to substantially similar exemption, applicants were also required to show that:• The Plan would pay no more than adequate consideration for insurance contracts

• No commissions would be paid by the Plan with respect to direct sale of contracts or the reinsurance thereof

• In the initial year, there would be immediate and objectively determined benefits to the plan's participants and beneficiaries (enhanced benefits)

• In subsequent years, the formula used to calculate premiums would be similar to formulae used by other insurers

• The Plan would only contract with insurer(s) with a rating of A‐ or better from A.M. Best Company, or another equivalent rating from another rating agency

• An Independent Fiduciary analyzed the transaction and rendered an opinion that the requirements above had been fulfilled

The DoL is focusing in detail on these areas

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TheReturnofEXPRO?• In March 2013, the DoL approved Coca‐Cola's individual exemption, allowing the reinsurance of Coca‐Cola's Life and AD&D policies in its South Carolina captive

• On April 10, 2014, the DoL approved Intel's individual exemption, allowing Intel to reinsure its Life and AD&D policies in its Hawaii captive

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DoLInstructions• The DoL has instructed employers seeking captive benefits funding arrangements to review the criteria met by Coca‐Cola and Intel• PTE 2013‐03 (Coca‐Cola)

• PTE 2014‐03 (Intel Corporation)

• While the criteria has not changed, the focus on certain regulatory issues has changed• The DoL is taking a closer look at benefits enhancement to ensure that such enhancements are long‐lasting and truly benefitting plan participants

• Accelerated Death Benefits

• Increased guaranteed issue

• Increase multiple of salary for optional life 46

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AnticipatedProjectTimeline

Ind. Fiduciary Review

In Depth Actuarial / Financial Modeling

High Level Review

Program Design / Benefit Enhancements

Go Live

ONGOING PROJECT MANAGEMENT & LEGAL COUNSEL

Approval

Submission Development

Fronting Carrier request for proposal (RFP) / Existing Carrier Negotiations

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GoingForward…

• Intel's PTE approval, combined with Coca‐Cola's PTE may

usher in a new wave of funding employee benefits in a

captive

• In the past, applicants were required to point to two

substantially similar PTEs and now the employee benefits

world has the Coca‐Cola and Intel PTEs to lead the way

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U.S.FederalIncomeTaxConsiderations

AssociatedwithEmployeeBenefitsCaptives

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Overview• Two primary questions to consider:

• Does the captive qualify as an insurance company for purposes of the insurance company provisions of the Internal Revenue Code (i.e., Subchapter L)?

• Does the arrangement involving the captive constitute insurance for U.S. federal income tax purposes?

• If it is determined that the captive qualifies as an insurance company and that the arrangement involving the captive constitutes insurance:

• The captive is afforded the ability to establish and maintain tax‐deductible reserves with respect to the arrangement; and

• The premiums paid to the captive under the arrangement generally qualify as tax‐deductible business expenses

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© 2015 William R. Pauls

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InsuranceCompanyStatus• For purposes of Subchapter L, the term "insurance company" means any company more than half of the business of which during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies (see IRC §§816(a), 831(c))

• Whether more than half of the company's business constitutes the issuance of insurance or annuity contracts or the reinsurance of risks underwritten by insurance companies depends on the facts and circumstances of each situation

• Accordingly, it is the character of the business actually done during the taxable year that determines whether a company is taxable as an insurance company

• Note: The determination of the company's status as an insurance company must be performed annually

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InsuranceCharacterization• The determination of whether an arrangement constitutes "insurance" for U.S. federal income tax purposes typically involves an analysis of the following requirements:

• Does the arrangement involve insurance risk, not merely investment risk or business risk?

• Does the arrangement provide both risk shifting and risk distribution?

• Does the arrangement constitute insurance "in the commonly accepted sense"?

• See AMERCO v. Commissioner, 96 T.C. 18 (1991), aff'd, 979 F.2d 162 (9th Cir. 1992); Rev. Rul. 2002‐90

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InsuranceCharacterization(cont'd)• The question of whether an arrangement involving a captive constitutes insurance for U.S. federal income tax purposes has a long and contentious history

• The resolution of this question generally depends on the facts and circumstances of the particular situation

• The factors that typically are taken into account when making this determination include:

• The portion of the captive's total risks that are attributable to unrelated parties;

• The capitalization of the captive; and

• Whether related parties provide guarantees (or other financial enhancements) for the benefit of the captive

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Unrelated‐PartyRisk• In Rev. Rul. 2002‐89, the IRS considered two situations in which a wholly owned captive insured the professional liability risks of its parent company, either directly or through reinsurance, as well as similar risks of unrelated parties

• In Situation 1, the premiums paid by the parent company to the captive, and the risks assumed by the captive from the parent company, constituted 90% of the captive's total premiums earned and risks borne for the taxable year

• In Situation 2, the premiums paid by the parent company to the captive, and the risks assumed by the captive from the parent company, constituted less than 50% of the captive's total premiums earned and risks borne for the taxable year 54


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Unrelated‐PartyRisk(cont'd)

• Situation 1: The IRS concluded that the arrangement between the parent company and the captive did notconstitute insurance for U.S. federal income tax purposes

• The IRS reasoned that the requisite risk shifting and risk distribution were not present because too large a portion of the captive's premiums and risks were from the parent company

• Situation 2: In contrast to Situation 1, the IRS concluded that the arrangement between the parent company and the captive in Situation 2 constituted insurance for U.S. federal income tax purposes

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Unrelated‐PartyRisk(cont'd)

• Rev. Rul. 2002‐89 delineates the following thresholds with respect to the effect of a captive's risk profile on the determination of whether the captive's coverage of the risks of its parent company constitutes insurance for U.S. federal income tax purposes:

• 90% parent company risk / 10% unrelated‐party risk –These facts may preclude the arrangement from being treated as insurance for U.S. federal income tax purposes

• Less than 50% parent company risk / greater than 50% unrelated‐party risk – Although not conclusive, these facts support the conclusion that the arrangement constitutes insurance for U.S. federal income tax purposes

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TreatmentofEmployeeRisk• Three principal authorities usually are cited for guidance on the topic of whether the employees of the parent company of a captive (or of any other affiliates of the captive) should be treated as parties that are unrelated to the captive and, correspondingly, whether the risks of those employees should be treated as unrelated‐party risks

• Rev. Rul. 92‐93

• Rev. Rul. 92‐94

• Rev. Rul. 2014‐15 (issued by the IRS in May 2014)

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Rev.Rul.92‐93Facts• In Rev. Rul. 92‐93, the IRS considered a situation in which X, a domestic manufacturing corporation, obtains for each of its employees $100,000 of life insurance coverage under a nonparticipating group term life insurance contract

• The group term life insurance contract is issued to X by S1, a wholly owned insurance subsidiary of X

• S1 is engaged in the trade or business of issuing life insurance and annuity contracts to the public

• S1 is regulated as an insurance company by the states where it transacts business

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Rev.Rul.92‐93Facts(cont'd)• The group term life insurance contract issued by S1 to X qualifies as a life insurance contract under applicable state law

• The contractual terms, including the premium rates, are customary in the industry

• X is not a direct or indirect beneficiary under the contract, and the proceeds of the contract are payable to the employees' beneficiaries

• There is no guarantee of a renewal of the contract by S1

• There are no permanent benefits (for example, a cash surrender value) provided under the contract

• The employees do not reimburse X or pay any of the cost of the coverage

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Rev.Rul.92‐93Facts(cont'd)

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X

Public

S1

100%

Public S1 is engaged in the business of issuing life insurance and annuity contracts to the public

S1 issues nonparticipating group term life insurance contract to X

$$

$$


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Rev.Rul.92‐93Analysis• Although X purchased the group term life insurance contract from its wholly owned insurance subsidiary S1, the IRS concluded that fact did not cause the arrangement to be "self‐insurance" because "the economic risk of loss being insured . . . is not a risk of X"

• The IRS reasoned that the insurance on the employees' lives relieved them of the expense of obtaining life insurance for themselves, thus it constituted an economic benefit to the employees and, correspondingly, compensation to them

• Accordingly, X was allowed to deduct the premium paid to S1 for the group term life insurance on an employee to the extent that the aggregate amount of compensation for the employee's services did not exceed reasonable compensation for those services (cf. Rev. Rul. 56‐400)

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Rev.Rul.92‐93Analysis(cont'd)• Notably, the IRS stated in Rev. Rul. 92‐93 that its reasoning also applies to accident and health insurance

• Thus, an employer may deduct the premiums paid to its wholly owned insurance subsidiary for accident and health insurance on an employee, provided the aggregate amount of compensation to the employee does not exceed reasonable compensation

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Rev.Rul.92‐94Facts• Rev. Rul. 92‐94 involves a situation in which a non‐life insurance company, IC, is insuring its own employees

• IC charges itself an amount representing premiums for its liability to pay insurance and annuity benefits for its employees and includes that amount in gross premiums written on its annual statement

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Rev.Rul.92‐94Analysis• The IRS concluded that the amounts that IC charges itself with respect to its liability for insurance and annuity benefits for its employees must be taken into account in computing IC's gross premiums written under IRC §832(b)(4)

• The IRS also recognized that IC's assumption of this liability is not the equivalent of self‐insurance "because the assumption shifts the employee's risks to the insurance company"

• Thus, the IRS concluded that deductions for the amounts that IC charged itself as premiums were not barred 64


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Rev.Rul.2014‐15Facts• Rev. Rul. 2014‐15 describes a situation in which a domestic corporation, X, voluntarily provides health benefits to a large group of named retired employees and their dependents

• X makes a contribution to its single‐employer voluntary employees' beneficiary association (VEBA) to provide the health benefits

• Rather than providing the health benefits to retirees and their dependents on a self‐insured basis, the VEBA enters into a contract (Contract A) with an unrelated life insurance company, IC

• Under Contract A, which provides noncancellable accident and health insurance coverage, IC will reimburse the VEBA for medical claims that are incurred by the covered retirees and their dependents and paid by the VEBA

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Rev.Rul.2014‐15Facts(cont'd)• In order to keep the premium payment under Contract A affordable, IC enters into a separate indemnity reinsurance contract (Contract B) with X's wholly owned subsidiary (S1), under which S1 receives a premium and reinsures 100% of IC's liabilities under Contract A

• Contract B is S1's sole business

• IC's participation in this arrangement is a condition of an exemption from the Department of Labor (DoL) from certain of the prohibited transaction provisions of the Employee Retirement Income Security Act (ERISA)

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Rev.Rul.2014‐15Facts(cont'd)• The IRS also assumed the following points of factual significance:

• S1 is regulated as an insurance company under state law;

• S1 possesses adequate capital to fulfill its obligations to IC under Contract B;

• Contract B is regulated as insurance;

• The amount of premium under Contract B is determined at arm's length in accordance with applicable insurance industry standards;

• There are no guarantees that the VEBA or X will reimburse S1 with respect to S1's obligations under Contract B;

• None of the premium received by S1 for Contract B is loaned back to the VEBA or X; and

• In all respects, the parties to the arrangement conduct themselves consistent with the standards applicable to an insurance arrangement between unrelated parties

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Rev.Rul.2014‐15Facts(cont'd)

X

Public

S1

100%

Pursuant to Contract B, S1 reinsures 100% of IC's liabilities under Contract A

IC issues Contract A to VEBA

VEBA

X contributes $$ to VEBA

ICContract B is S1's sole business

$$

$$

1

2

3

Contract B

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Rev.Rul.2014‐15Analysis• The IRS focused its analysis on the question of whose risk is being insured by S1 – specifically, X, the VEBA, or the covered retirees and their dependents

• The IRS reasoned that the risks being indemnified by S1 are the covered retirees' and their dependents' risks of incurring medical expenses during retirement due to accident and health contingencies and, thus, are unrelated‐party risks

• Accordingly, the IRS concluded that Contract B constitutes insurance for U.S. federal income tax purposes and, because Contract B is more than half of the business done by S1 during the taxable year, S1 qualifies as an insurance company under Subchapter L for the taxable year 69


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Rev.Rul.2014‐15Analysis(cont'd)• Based on its analysis in Rev. Rul. 2014‐15, it appears that the IRS viewed the following facts as determinative:

• Although the VEBA entered into Contract A, the covered retirees' health insurance is an economic benefit to the retirees because it relieves them of the expense of buying health insurance for themselves and their dependents

• At the time that Contract A goes into effect, neither X nor the VEBA has any obligation to offer health benefits to the covered retirees and their dependents

• Both X and the VEBA may cancel the health benefits coverage at any time 70


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PartingThoughts• Rev. Rul. 2014‐15 confirms the continuing vitality of Rev. Rul. 92‐93 and the notion that the employees of the parent company of a captive (or of any other affiliates of the captive) should not be viewed as parties that are related to the captive and, correspondingly, that the risks of those employees should be treated as unrelated‐party risks for purposes of the insurance analysis

• Rev. Rul. 2014‐15 does not speak to, and otherwise does not cover, the use of a captive to insure medical stop loss coverage for its parent company's self‐funded health benefits, although this topic clearly is ripe for guidance

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ThankYou!Questions?

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Any tax advice contained in this document is not intended or written to be used for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code of 1986, as amended, or any other applicable tax law or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

#ACIInsurance

AboutthePresenters

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PeterJ.Bandarenko• Senior Consultant and Head of New Market Development

at Spring Consulting Group, LLC, a leading consulting andactuarial firm.

• Peter has more than 25 years of insurance industryexperience and is a recognized industry leader inemployee benefits, risk financing, captive reinsurance andnew product development. Peter has deep expertise intechnical consulting and sales, client relationshipmanagement and new product development, and has atrack record of success in both the insurance carrier andbroker/consulting fields.

• Peter works with companies and plan sponsors of all sizeson strategy, design and implementation of creativeinsurance solutions and risk financing arrangements withfocused expertise in captives, global/multinationalemployee benefits solutions, retirement benefits,voluntary benefits, executive benefits and new productdevelopment.

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LinkedIn: spring‐consulting‐group‐llcTwitter:@SpringsInsightWeb: www.springgroup.comEmail: [email protected]: 857‐239‐1240

#ACIInsurance

StevenR.BaumanSteven Bauman is currently a Senior Vice President with Zurich Global Corporate in

North America (GCiNA), located in the New York office. He is Head of Captive Servicesfor Zurich's GCiNA division. His responsibility is to help customers with captive insurerscreatively and seamlessly integrate their captives into their insurance strategies.

Over the course of his 25 year career, Mr. Bauman has coordinated business inmore than 60 countries and has personally traveled to more than 35 countriesspanning six continents. His primary areas of expertise are in corporate property andcasualty insurance and reinsurance, with an emphasis on captive programs for largenational and multinational corporations. Such captive programs integrate the use ofvarious loss retention mechanisms, risk transfer and reinsurance products for amultitude of product lines, including but not limited to: workers' compensation;general & product liability; automobile liability; property; marine; terrorism;professional liability, weather and employee benefits.

He is an active member in several professional organizations including Risk andInsurance Management Society (RIMS) New York Chapter, Captive Insurance Council ofthe District of Columbia (CIC‐DC), Delaware Captive Insurance Association and theVermont Captive Insurance Association (VCIA), where he is a member of the Board ofDirectors and a member of the Legislative and Conference Committees. He oftenvolunteers his professional expertise to assist the advancement of the industry,including his current work as a member of the Board of Directors for the InternationalCenter for Captive Insurance Education (ICCIE) and his work with several U.S. stategovernments on issues related to their captive insurance company domiciles.

Mr. Bauman holds a Bachelor of Arts degree from Colgate University with majors inboth economics and political science. He holds a Masters in Management fromStevens Institute of Technology.

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Phone: 917 534 4857Cell: 347 324 8977Email:[email protected]

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BrianT.CaseyBRIAN T. CASEY is a partner in the Atlanta office of

Locke Lord LLP. As co‐leader of Locke Lord'sRegulatory and Transactional Insurance PracticeGroup, and a member of the Firm's Corporate,Capital Markets and Health Care Practice Groups, Mr.Casey focuses on corporate, merger & acquisition,corporate and structured finance and othertransactional, and regulatory matters for corporateclients in the insurance, financial services and healthcare industries.

One significant facet to Mr. Casey's practice is afocus on insurance‐linked securities and relatedinsurance capital markets transactions. His clientsinclude insurance companies, insurance holdingcompanies, managing general agents and insuranceagencies, third party and claims administrators, banksand other financial institutions, investment banks andreinsurance companies.

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Phone: (404) 870‐4638Email: [email protected]

#ACIInsurance

William Pauls provides innovative solutions to a broad array ofcomplex federal tax issues faced by insurers, reinsurers, and othermultinational corporate clients. With more than a decade oftransactional planning experience, William regularly advises clients withrespect to structuring and implementing corporate reorganizations,stock and asset acquisitions and dispositions, cross‐border transactions,spin‐offs and other corporate separations, internal restructurings,reinsurance transactions, and captive insurance companyarrangements. William also offers clients critical analysis concerning theapplication of the consolidated return regulations and the resolution ofmultifaceted international tax issues, including the application of theForeign Account Tax Compliance Act (FATCA), the dual consolidated lossrules, and the insurance provisions of Subpart F.

Before joining Sutherland, William served as a law clerk for theHonorable Mary Ann Cohen of the United States Tax Court. Williamleverages this experience while representing clients before the InternalRevenue Service and in federal courts. In addition to handling federaltax controversies, William's practice before the Internal Revenue Serviceincludes obtaining letter rulings that address consolidated return issues,corporate transactional matters, and international tax questions.

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WilliamR.Pauls

202.383.0264 (direct)[email protected]

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