CAPTIVE INSURANCE COMPANIES ASSOCIATION


CAPTIVE DIFFERENTIATORS


Modus operandi (continued)


Uses an investment manager Doesn’t use an investment manager Where they don’t, the costs may be lower, but so, generally, is the total return. In some unmanaged cases, the captive’s security is also considered to be lower.


Diversifies investments to increase income


Expense ratio <15 percent Stays short, in government bonds Expense ratio >30 percent Return on equity <10 percent Return on equity >15 percent


Combined ratio close to or equal to 100 percent


Clear mission statement Own data system Rated


Includes one or more independent board members


Comes to CICA meetings


Has challenged captive’s modus operandi, raison d’être and existence


Active


Combined ratio either >100 percent or <50 percent


None, or poorly worded Depends on someone else’s Not rated Doesn’t Never does Never has Dormant


In 2012, low interest rates call for greater asset management than in the days when CICA members’ captives earned most of their annual profit from their investments.


Includes costs of fronting, but not reinsurance. Low expense ratios are good, but not always. Higher ones are often a bad sign, although again, not always.


Mature captives with high net equity often show lower return on equity than younger captives. High return on equity is one sure sign of overcharging (see break-even differentiator, above) but may also be a sign of high risk-taking.


This is the big differentiator of captives from commercial insurers. Where the ratio is too high there will be trouble from the captive’s shareholders and regulators, where too low, from its insureds. See also ‘break-even’, below.


Often the mission statement isn’t written, but says that it is to ‘provide the best insurance deal for its insureds’ rather than something like ‘making reasonable profits’ which places the captive on sounder ground.


Better information about their exposures and losses are what differentiates captives from commercial insurers.


An AM Best or S&P rating is a sign of confidence in a captive. Definitions of ‘independent’ also reveal significant differences. Those who come find out a lot about how their captive compares to others.


The most stable and successful captives have looked at shutting down, morphing to a cell, or challenging their management and governance.


There are a lot of inactive captives, notably offshore. They are usually counted in the statistics of captives.


Tax position


Owner takes (gets) deduction


Writing >30 percent unrelated business


If offshore and US-owned, doesn’t make the 953(d) election


Breaks even


Files and pays its own income tax


Doesn’t Writing less, or none Makes the election Makes significant profits


Consolidated with a larger taxable entity Or


Members declare their individual share of earnings and profits


Member/owners file and pay self-procurement taxes


Don’t Lends assets back to owners No loan-backs


If small, uses 831(b) exemption


Participates in pooling with other captives


Doesn’t Doesn’t A number of US owners of captives don’t. Non-profit owners, for instance. Most captives don’t write any unrelated business, but would like to, to improve their tax position. Many US-owned offshore captives don’t, notably those owned by non-profits. Owners of break-even captives have far fewer tax concerns. Most onshore single-owner captives are consolidated.


Offshore group captives in zero-tax jurisdictions don’t have any income tax to pay—the irreducible offshore tax advantage. Their US members do, though.


A hot topic among tax advisors. Most captives don’t, but wouldn’t admit it.


Tax and regulatory authorities dislike loan-backs. So does Solvency II. But they are a common feature of advanced captives.


If the captive does, there are usually estate planning or tax avoidance reasons. Pooling, especially for 831(b) captives, is mainly a tax position.


CICA | Forty years of captive leadership


37


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