Coming up captives

This year’s Captive Insurance Companies Association (CICA) International Conference was Dennis Harwick’s last as president.

At the event, held in San Diego earlier in March, Harwick thanked the many professionals he has had the pleasure to work with during his 12 years in the role. Harwick said: “My goal was to make partners throughout the industry and make CICA a domicile-neutral association for the whole captive world and you can’t do it alone. I have been blessed with hardworking administration staff. I thank you for the honour of having served as your president and I appreciate it.”

Dan Towle, director of financial services for Vermont, will take over from Harwick in April and is set to participate in his first CICA board meeting in June.

As well as celebrating Harwick’s time at CICA, two awards were distributed for contributions to the captive insurance industry. Karin Landry, managing partner of Spring Consulting Group, received the 2017 CICA distinguished service award, while Fiat Lux Risk and Insurance Company was presented with the 2017 outstanding captive award.

Disruptive times

The theme of this year’s conference was defying disruption, which Harwick suggested was fitting because of the amount of discussion around the topic in the industry. The keynote speaker, Lindsey Pollak, a millennial workplace expert, revealed that by 2018, a quarter of the insurance workforce is set to retire, which she described as “disruption at its definition”.

Pollak encouraged delegates to include the younger generation in their business plans and decisions. She suggested that training and educating millennials could be a big opportunity for businesses and corporations.

A good example of the younger generation getting involved in the captive insurance industry is the Butler University College of Business, which is launching a student-run insurance company on 1 May this year. The Butler captive will insure certain programmes, including the live mascot, Butler Blue III, and any physical damage to university vehicles.

The aim of the captive is to give students hands-on experience and prepare them for an industry that expects to need tens of thousands of new employees over the next seven years.

In another session, panellists discussed the rise of technology and how it is driving captive growth, as trickier coverages are required to cover new risks.

Michael Serricchio, senior vice president in the captive advisory group at Marsh, noted that non-traditional coverages, such as employee benefits, supply chain, cyber, political risk and medical stop-loss, have increasingly been put into captives over the last few years due to advances in technology.

Technology-reliant industries, such as financial services and media, are also among the biggest users of captives, with the former writing up to $19 billion in premiums and the latter $4.9 billion.

Another panellist, Karl Pedersen, senior advisory specialist at Marsh, pointed to cyber as the most inevitable risk to arise from technology advances, with hacks becoming more of a question of when than if.

Many types of assets exist within organisations, including intellectual property and data that are vulnerable to cyber attacks, according to Pedersen. Breaches should be dealt with in three assessment phases, covering risk/loss, damages and coverages.

The panel noted that coverage of cyber policies has started to broaden, with lines including terrorism and property damage.

When asked if commercial insurance or captive insurance was better for cyber coverage, Pedersen said that it depends on the needs of the business, but captives might be able to do what commercial insurers cannot.

Micro captives were also part of many discussions at this year’s conference, after the US Internal Revenue Service’s (IRS) renewed interest in them with Notice 2016-66.

In one panel, Dana Sheridan, general counsel and chief compliance officer of Active Captive Management, and Jeffrey Simpson, director at law firm Gordon, Fournaris & Mammarella, launched a staunch defence of 831(b) insurers.

Sheridan said that small- and medium-sized entities are having a hard time of it right now simply because there is a misperception in Washington DC about the captive industry.

She said: “The IRS admits in Notice 2016-66 that they don’t actually know who the bad ones are, and they list stuff that they think is bad and request to hear from everyone required.”

Released in November last year, Notice 2016-66 formally labelled 831(b) captives as ‘transactions of interest’. The IRS required them to report to the federal agency by 30 January 2017 due to their potential for tax avoidance or evasion. That deadline was subsequently pushed back to May.

The IRS has long been worried that captive arrangements such as those that elect to be taxed under Section 831(b) are fronts for tax avoidance or evasion. The IRS named micro captives in its annual ‘Dirty Dozen’ tax scam list in February, for the third year in a row.

Simpson suggested that the captive insurance industry needs one or two examples for guidance and to provide standards before it can readjust.

He said: “If there is anything that we as an industry need to do differently, we will do that accordingly, and if the IRS needs to adjust, they will do that. I think there is a bright future for 831(b) captives.”

Skip Myers, partner of the insurance group at Morris, Manning and Martin, and Jim McIntyre, partner of McIntyre & Lemon, raised concerns about the reputation of the captive industry.

Myers suggested that the IRS’s Notice 2016-66 adds a “taint” to the industry. He said: “The notice has already had a chilling effect on the industry, along with the requirements of the PATH Act, which are essentially aimed at getting rid of the opportunity for state planning or transfer of wealth from one generation to another and avoiding gift tax.”

He added: “It’s taking its toll and it is going to continue to be an issue for the whole captive industry.”

McIntyre suggested that there is nothing wrong with taking the 831(b) election if a captive qualifies.

He said: “The real issue is whether the captive is being set up for purely insurance purposes or whether it is being set up for wealth transfer and state planning purposes.”

“The issue is what that is going to do to the reputation of the captive industry. I think the captive industry should be concerned,” McIntyre added.

According to Myers, CICA’s position has always been to do captives right and not be driven by their tax benefits. He said: “Unfortunately, there are others who think the tax part of it is more significant than the risk management part of it.”

The panel also spoke about the recent completed covered agreement between the US and the EU.

The US Treasury and the Office of the US Trade Representative (USTR) completed negotiations with the EU on 13 January.

The agreement provides a mutual agreement of prudential supervision in the EU and the US, which will eliminate the increasing barriers to US groups operating in Europe.

The panel explained that the agreement was needed because the European Commission has not deemed the US as an equivalent jurisdiction for the Solvency II Directive, which means US companies would need to cover a lot of requirements to do business in the EU.

The panel said it eliminates the requirement for a local place of business for the host jurisdiction and eliminates the requirement for collateral. The agreement applies to companies that have more than $250 million in capital and the same in euro for EU countries.

According to Myers, there has been an interesting reaction to this agreement. The National Association of Insurance Commissioners (NAIC) has been particularly troubled by it. Although it wasn’t a part of negotiations, it was an observer.

Still, the NAIC has raised concerns about not being able to vote on the decision and transparency, and is concerned about the provision in the agreement for foreign jurisdictions to have regulatory authority over a US company.

Myers said the NAIC is looking at the agreement and is preparing amendments to submit to the US Treasury.

Other bodies, including the Reinsurance Association of America, believe the agreement brings some predictability to their members’ participation in the European markets, and vice versa, according to Myers.

While the agreement might not have any direct effect on captives, it could eliminate some barriers and stabilise pricing, which is good for captives, according to McIntyre.

Finally, the panel discussed possible changes around the Affordable Care Act (ACA).

The panel explained that although President Donald Trump and Republicans want to repeal or replace the ACA, it’s unclear what the replacement will ultimately look like.

Myers said: “The change, on balance, could be good for captives”.

“Captives now, even under the ACA, have grown in the healthcare space in terms of medical stop-loss for employer plans and that will continue to grow.”

“The fact the states will be more involved [will be positive]. I think we are heading for a system where there is more state control, which I think that is a good thing for captives.”
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