July 20, 2020

Jurisdictional Differences Explained

5 min read

R. Wesley Sierk, III ; Managing Director, Risk Management Advisors

A captive insurance company is created solely to write insurance for property and casualty for a small group of people. A Corporation sets up a pure captive insurance company with one or multiple subsidiaries. It depends on the jurisdiction where the captive generates revenue and what legislation they must abide by to become a licensed insurer. The parent company will bear the risk of the subsidiary captive companies. The captive company will understand the difficulties, risks, and premium levels and accept payment from the insured. These subsidiary companies will pay the captive company premium payments, which will become a regular insurance payment for the insured.

These captive insurance arrangements are typically deductible and can be claimed for tax exemption. A captive insurance structure aims to create a company that can finance its ventures and take risks. They will determine, through sophisticated risk management advice, how to make their private insurance program management. The regulation concerns guiding private insurance solutions depend on the following things.

Regulatory Framework: Public vs Private Insurance

Understanding the difference between these two is crucial. When the insurance of the general public is concerned, the insurer has to keep in mind that they cannot discriminate on the forms and rates, and they have to treat all applicants equally. Captive insurance owners do not have to be concerned about these issues. A traditional insurance company has to contribute a particular portion of its revenues into state-mandated funds, providing the insured payment protection. This requires that they guarantee they can provide the insured with the claim payment in situations where they have become eligible. This applies even when this firm has declared bankruptcy, in which case another insurer has to pay for the various taxes and other things needed to fund these. On the other hand, a captive insurance company is not mandated to contribute its earnings to these pools and make tax contributions. They do not have to follow many of the best insurance practices that traditional insurance companies have to follow.

Unique Aspects of Captive Insurance Operations

Captive insurance law dictates that captive insurance companies are, by definition, limited in their approaches. They have to be very specific about their needs, and some owners might think that the regulations will completely overlook the niche they are interested in or that the federal government will over-regulate them. Either way, regulations can significantly impact captive insurance companies.

The captive insurance industry is vast, and the advantages of strategic risk management solutions might benefit one owner differently from another, depending on which jurisdiction they are operating under. For example, taxation is one of the best examples of the difference two captive companies can have. Captive insurance companies need to mitigate risk in commercial activities but do not always get the same tax treatment. There is no unanimous approach and no singular voice that can determine the risk factors of these groups.

Regulatory Challenges in the Captive Insurance Industry

The main reason for that is that, generally, captive management partners fund the venture. This is why the owners often create their defense to protect their company's and area's regulatory needs. Some corporations work differently from one another, and enterprise risk management can be captured and handled only through uniquely designed solutions for enterprise risk. Because there is so much diversity in how captives work, developing a singular plan to address these issues can be difficult if the NAIC or the federal government brings any regulation in this sector. The risk transfer concepts from one company to another will differ, and the owner of a captive might even have to create a unique solution.

The NAIC regulations were designed to gain the upper hand, and regulatory suggestions can be made that change entirely how captive companies operate. Some of these suggestions can even work towards bridging the gap between traditional insurance companies and captive insurance companies, which could be disastrous for a captive organization. In this case, the advantage of strategic risk management solutions is undeniable.

Tax Considerations and IRS Oversight

For example, the IRS also focuses on particular captive insurance arrangements under the micro captive transaction umbrella. In these transactions, the owner of the business of the actuarial partners creates their captive to ensure the company's risk. The result of these features is that a transaction has to be made, which appears as insurance but cannot legally be considered insurance. This will help the captive beneficiaries in tax avoidance and provide a tax reduction to the business while providing a tax-free premium income to the captive organization.

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The contents of this article are for general informational purposes only and Risk Strategies Company makes no representation or warranty of any kind, express or implied, regarding the accuracy or completeness of any information contained herein. Any recommendations contained herein are intended to provide insight based on currently available information for consideration and should be vetted against applicable legal and business needs before application to a specific client.

R. Wesley Sierk, III ; Managing Director, Risk Management Advisors

Wesley Sierk is a recognized authority in the realm of captive insurance company design and management. As Managing Director and Lead Strategist for Risk Management Advisors, Inc., he possesses an unmatched track record that spans nearly 30 years, with a focus on empowering profitable, closely held businesses. Wesley's expertise isn't just limited to consultation; he's profoundly adept at strategic implementation. He has partnered with leading homebuilders, real estate developers, manufacturing enterprises, and professionals in sports and entertainment, providing them with unparalleled insights and solutions. A hallmark of Wesley's career has been his unwavering commitment to his education. He holds esteemed designations like the Chartered Financial Consultant (ChFC) and Chartered Life Underwriter, both awarded by the American College since 1996. Further amplifying his credentials is the CRIS (Construction Risk and Insurance Specialist) recognition, secured in 2006. Notably, he's among the rare individuals globally to have earned the Associate in Captive Insurance (ACI) designation, a testament to his profound understanding of the subject. Beyond his direct work with clients, Wesley takes immense pride in working hand-in-hand with other professionals, including CPAs, Attorneys, and Financial Advisors. This collaborative approach ensures thorough due diligence and optimal plan design implementation. An accomplished author, Wesley has penned critical works like Taken Captive: The Secret to Capturing Your Piece of America's Multi-Billion Dollar Insurance Industry and You Can Make It, But Can You Keep It?. The latter serves as a guiding light for the affluent, teaching them strategies to preserve their hard-earned assets. In the realm of speaking engagements, Wesley is a coveted name. Whether it's insurance industry gatherings or legal and accounting symposiums, he's regularly called upon to demystify the intricate dance between traditional insurance markets and the potential of captive insurance entities. Under Wesley's leadership, Risk Management Advisors remains a beacon of innovation, committed to elevating clients' financial well-being and mitigating risks in an ever-evolving landscape. He is married to Leslie and has two 'not so young' children. Their son is attending the University of Tennessee studying entrepreneurship and risk management. While their daughter finishes up her high school years. They love to travel, golf, cook and hike with their two huge dogs.