This GCP Live episode was recorded in front of a live audience as the closing session of the CICA International Conference in Palm Springs, California on Tuesday, 7 March.
Richard is joined by eight guests for a fun discussion, including hearing something new about each captive professional, sharing examples of captive innovation and competing in more captive trivia.
The eight panellists are:
Nick Troxell, Manager of Global Captive Fronting, Allianz
Cheryl Baker, Head of North American Risk Management, Stellantis
Jason Flaxbeard, Executive Managing Director – Alternative Risk, Brown & Brown
Anne Marie Towle, Global Captive Solutions Leader, Hylant
Dan Towle, President, CICA
Theresa Severson, Vice President of Insurance & Risk Management, Kite Realty
Paul Phillips, Partner and Global Captive Network Co-Leader, EY
Adriana Scherzinger, Head of Captives and Alternative Risk Solutions, Zurich North America
For news, analysis and thought leadership on the global captive insurance market, visit the Captive Intelligence website.
Marsh Captive Solutions has established a cell captive facility in Delaware, specifically designed to serve clients seeking alternative risk transfer options for Side A directors and officers (D&O) insurance.
Marsh has been a leading voice on captive options for Side A since the D&O market hardened significantly four years ago, with clients utilising cells, often in Bermuda, as they sought alternatives to the commercial market.
In February 2022, Delaware’s corporate code was amended to expressly permit the use of captives to self-insure most Side A exposures of businesses that are headquartered in the State.
Captive Intelligence revealed in December that social media giant Meta had transformed its Hawaii-domiciled pure captive into a sponsored captive with a cell being used to self-fund Side A D&O, taking advantage of the Delaware legislative change.
We understand at least one other Hawaii captive, owned by a Delaware corporate, has since replicated that structure.
Despite Marsh already having cell companies in Washington DC, Vermont, Bermuda, Malta and Guernsey, Donna Weber, senior vice president and pooling & cell facilities leader, told Captive Intelligence they specifically wanted a Delaware facility for Side A D&O risks.
“The approved Delaware law is a significant step forward as it allows more companies to consider a wholly owned captive or a “cell” as a partial or complete solution for covering Side A D&O claims,” Weber said.
“We feel that the combination of the new Delaware law, combined with utilisation of a cell facility domiciled in Delaware, provides the closest alternative to commercial insurance with least amount of potential issues.
“As one example, since both the corporate law and the captive law are both Delaware, potential public policy conflicts that may arise if the captive is domiciled outside of DE are removed.”
Weber said that the Side A cell option would be of particular interest to companies facing high premiums or “struggling to obtain sufficient capacity in the commercial market”.
She added that in some instances the cell option may be a better solution than utilising a pure captive already in the group.
“The use of a protected or segregated cell facility (PCC) is more arms-length from the company itself and therefore might be a better fit to fund non-indemnified loss,” Weber explained.
“A PCC is a stand-alone entity with ownership, management, and control largely independent of the company seeking to insure its directors and officers.
“Decisions related to the policy’s response and the provision of Side A D&O coverage can be set up to be independent of the company. Potential concerns about influence by the company’s management and concerns about disgruntled shareholders should be ameliorated.”
US domiciles open to licensing cannabis captives, but await further state and/or federal legalisation
States report strong start to 2023 licensing activity
Hard insurance market, particularly in property, driving new formations
Captive regulators in the United States canvassed by Captive Intelligence at the 2023 CICA International Conference discussed the potential for licensing cannabis captives, as well as the impact of the hard market, new legislation and the 831(b) tax election.
Some form of medical marijuana is now legal in 37 states, while 21 states have legalised recreational marijuana use. The product, however, remains illegal at the federal level, which makes banking and insurance procurement challenging.
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Nick Hentges, CEO and principal of Captive Resources, LLC, has been appointed the new chair of the board of directors of the Captive Insurance Companies Association (CICA).
Hentges has been with Captive Resources since 1993 and led them in various roles since 2014.
He has been a member of the CICA board since 2020 and also serves on CICA’s NEXTGen Committee.
“This is a phenomenal time to be involved in captive insurance and I am honoured to serve as CICA’s Board Chair,” said Hentges.
“As CICA and the captive industry grow I look forward to working with my board colleagues and our volunteer leaders. We want to provide the education, advocacy, best practices and professional development our members need to help their captives create the innovative solutions that fuel our industry’s growth.”
Mary Ellen Moriarty, vice president for property & casualty at EEIA, has been elected vice chair while Heather McClure, chief risk advisor for Aon’s US Healthcare Practice is now secretary/treasurer of CICA.
Renea Louie, chief operations officer at Pro Group Captive Management Services, serves as the immediate past chair.
Cheryl Baker, head of North American risk management at Stellantis, and Prabal Lakhanpal, vice president at Spring Consulting Group, have been appointed as new CICA board members.
Courtney Claflin, head of insurance at Fluid Truck, Colin Donovan, president of STICO Mutual Insurance Company, a Risk Retention Group, Deyna Feng, director of captive programs at Cummins Risk International, Udo Kappes, director at RWE AG, and Michael Zuckerman, assistant professor at Temple University, are returning CICA board members.
Managing general agent Xchange Benefits, owned by Ambac Financial Group, has appointed New Jersey-based Christopher LaDelfa as senior vice president and head of its captive solutions unit.
The captive solutions unit is a newly created division that will utilise Xchange’s wholly owned protected cell company, Distribution Re.
LaDelfa spent the last five years at Berkley Accident and Health, where he was director of programme management. Prior to that he was with AJ Gallagher for 14 years.
“I am so pleased that Chris with his nearly 20 years of stop loss industry experience, integrity and reputation has agreed to join the Xchange team,” said Peter McGuire, CEO of Xchange Benefits.
“Chris has been deeply immersed in the delivery of captive solutions for a number of years and so is more than equipped to grow this important capability for Xchange.”
Distribution Re, which is domiciled in Tennessee, insurers accident and health risks mainly in the form of high deductible medical stop loss plans and was launched earlier this year.
LaDelfa said: “I am honoured to join the Xchange leadership team and leverage my unique employee benefits and group captive experience to help grow and support the captive segment at XB.
“Peter McGuire and his team are proven professionals and Xchange is well positioned for continued growth and success. I am very excited to get started.”
McGuire recently spoke with Captive Intelligence for a long read exploring how MGAs are increasingly launching their own captives as a means of accessing more capacity and profiting from their book of business.
AIS provides outsourced claims administration services to medical stop loss managing general underwriters (MGUs) as well as claims review and audit services to insurance companies.
“We have been impressed by the level of services provided by AIS and the best practices they bring to the operation of a medical stop loss claims department,” said Brady Young, president and CEO of SRS.
“This is a great opportunity to bring these services to our clients and partners and continue to grow AIS. The expansion of our services into claims administration in the medical stop loss space is consistent with the selective addition of services complementary to our captive management business.”
AIS was only founded in 2021 by Anne Trupiano, Robyn Eagan, and Nina Carrico and is headquartered in Massachusetts, operating across the United States.
Eagan and Carico will continue as vice presidents of the company with Trupiano leaving the business.
“We are grateful for the opportunity we have had to start AIS and work with Anne Trupiano to successfully establish the company,” said Eagan.
“We are also excited to build out our vision for a best-in-class claims administration company with the support of SRS.
“Their reputation within the alternative market and relationships with brokers, employers, insurance companies and other service providers provides an ideal platform for us to deliver and enhance our services.”
Risk and Insurance Strategy Consultants (RISCS) and Cutts-Watson Consulting (CWC) have completed the merger of their respective businesses and will now be known as RISCS CWC.
Captive Intelligence revealed in January that the two independent captive consulting firms had agreed to merge, creating a business with a global footprint, including physical presence in the UK, Guernsey, France, South Africa and the Cayman Islands.
Olive Schofield is CEO of RISCS CWC with Malcolm Cutts-Watson taking the position of non-executive chairman.
“This merger is a significant step towards our vision to be the number one independent global captive & ART consultant,” Schofield said.
“Already our expanded team of consultants are working together on a range of exciting engagements. We see this merger as a springboard to further growth across the globe.”
Cutts-Watson said: “I’m delighted to advise the merger went smoothly and the combined resources of RISCS CWC are now available to all our clients.”
Schofield and Cutts-Watson joined an exclusive episode of the Global Captive Podcast in January to provide more details of the merger, how it came about and their ultimate ambitions for the combined entity.
Atlanta-based Doug Butler, formerly of Moore Ingram Johnson & Steele, LLP, has joined Womble Bond Dickinson as partner in the firm’s corporate and securities group.
Butler will provide outside counsel to captive managers and owners advising on insurance regulatory matters, formations, coverage matters and claims assistance.
“Doug is highly regarded as an excellent lawyer in the captive insurance industry,” said Jamie J. Francis, leader of the Corporate & Securities group.
“His unique perspective as a former captive manager will be extremely beneficial to our clients in the corporate and securities industry, and we are excited to welcome him to the firm.”
Jeffrey K. Simpson, who leads Womble Bond Dickinson’s captive insurance practice, said: “Adding Doug to our team expands the reach of our practice in both subject matter and geography.
“He has experience with a variety of regulatory issues in multiple U.S. domiciles. As our practice expands to meet the needs of our clients, Doug is a perfect complement.”
Mikhail Raybshteyn is a tax partner in the Ernst & Young LLP Financial Services Organization Insurance Sector and is the Americas Captive Insurance Services Co-leader, focused on US federal, state and international tax matters. Mikhail can be reached at +1 516 336 0255 or email here.
Nicole Henderson is a transfer pricing senior manager in the Ernst & Young LLP Financial Services Organisation. She has over a decade of experience in providing US and foreign transfer pricing services to clients in multiple industries, with special focus on traditional and captive insurance. She can be reached at +1 (212) 773-0118 or email here.
Nicole Henderson and Mikhail Raybshteyn of Ernst & Young LLP explore how transfer pricing can affect captive insurance arrangements, including a captive’s insurance premium tax and insured’s self-procurement tax obligations.
The tax considerations for captive owners and captive managers have increased over the years. While aware of the possible tax benefits of owning and insuring risks through a captive insurance arrangement, many owners and managers may be unaware of how transfer pricing can affect that arrangement. This article explores the effects of transfer pricing on captives’ determination and allocation of premiums, as well as its effects on a captive’s insurance premium taxes (“IPT”) and an insured’s self-procurement tax (“SPT”).
Overview of transfer pricing
Transfer pricing regulations require prices charged between related parties to be arm’s length (i.e., the price to which two related parties agree in a transaction is the same as the price to which two unrelated parties agree in a comparable transaction).
In the traditional insurance context, premiums paid by multinationals to a third-party insurance company are inherently arm’s length because the transaction is between two completely unrelated parties; in the captive insurance context, however, transfer pricing dictates that transactions between members of a group must be priced on an arm’s-length basis.
Intercompany transactions typically observed and analyzed in a captive insurance context primarily include the following:
Arm’s-length premium for insurance policies placed through the captive (a related party)
Arm’s-length allocation of premium amongst the members of a group based on the benefit received
Other intercompany transactions that can arise include sales commissions or referral fees paid. This is a common fact pattern for extended warranties insured by a captive when the multinational sells electronics, cars or other similar products.
Focus on transfer pricing by tax authorities globally
Multinational companies have generally not focused much attention on transfer pricing for their captives. As a general market observation, global tax authorities, in contrast, have steadily increased their transfer pricing focus.
This increased focus stems, in part, from a larger international effort, led by the Organisation for Economic Co-operation and Development (“OECD”), to ensure that multinational enterprises pay tax wherever they operate.
These efforts have been ongoing since 2013 through the release of 15 action items by the OECD intended to stem Base Erosion and Profit Shifting (“BEPS”).
In the US, the Internal Revenue Service (“IRS”) is increasing its headcount to be able to audit companies’ transfer pricing, according to Tax Notes article quoting Robin Greenhouse, LB&I division counsel during a January 18, 2023, meeting of the American Bar Association Section of Taxation.
If that happens, exam agents will likely assess whether intercompany transactions are conducted on an arm’s-length basis and whether the captive has enough substance to achieve the level of profit expected to be earned. Substance includes not only headcount employed by the captive (as majority of the captives actually use approved third-party management companies), but also a sufficient level of oversight and seniority to make decisions on behalf of the captive and accept risks assumed on the captive’s balance sheet.
To support the level of substance in a captive, companies must perform a functional analysis. This analysis addresses the end-to-end value chain of a group, including the functions performed, risks assumed and managed, and assets used and owned by the captive and its interaction with the broader multinational. Documenting this analysis places the burden of proof from the taxpayer back to the IRS.
Absent this support, US tax authorities could determine that a company has failed to demonstrate that its captive has adequate substance, resulting in potential tax assessments and/or penalties.
Transfer pricing analysis for captives
In addition to establishing an appropriate level of substance in the captive, companies must price premiums between the captive and insureds on an arm’s-length basis. This analysis is relevant to perform both when the captive is established and on an annual basis.
Most captives employ actuarial assistance to set the premium for risks they insure. Transfer pricing and actuarial analyses are not mutually exclusive; transfer pricing professionals look to the actuaries to price the premiums and rely on their assumptions, but an actuarial analysis does not replace a transfer pricing analysis.
Actuaries have to make significant assumptions that comply with actuarial standards but may not be consistent with arm’s-length behavior. For example, actuaries may use an industry-wide expense loading if historical data is lacking and the likelihood of paying a claim is high; however, the transfer pricing regulations stipulate a higher degree of comparability in the analysis.
As a result, additional benchmarking may be required from a transfer pricing perspective to support the expense loading for the same level of the market and comparable risks insured, or even to present the analysis in a clearer manner that the tax authorities can understand based on experiences outside of the captive insurance industry.
Absent historical data on certain risks insured by the captive, transfer pricing analysis can also be a useful resource for finding market comparables to establish market ranges for various components of the premium, including both the profit margin and expense loading.
Allocation of premiums
Often times, multinational groups purchase an insurance policy by one entity for administrative ease, but that policy benefits the overall group. Once the premiums are determined to be arm’s length, they may then need to be further allocated amongst group members that benefit from the insurance policy on an arm’s-length basis.
Companies should allocate premiums based on the following considerations:
The risk covered by the policy
The beneficiaries of the insurance ( i.e., entities benefiting from the coverage actually pay for the coverage)
The global supply chain of the company
Global transfer pricing policies of the group
No single method is the answer. The allocation methodology needs to consider multiple aspects of the insured group and its operations, resulting in the most prudent approach to allocate premiums.
If we take business interruption risk as an example, multiple entities throughout a multinational could be impacted by a business interruption and benefit from the associated insurance policy. The extent to which each entity benefits from a policy’s coverage may depend on the group’s global supply chain and the general transfer pricing policy to remunerate related-party transactions.
For example, an entity that is an entrepreneur and receives residual profits and losses will be affected disproportionately by the business interrupted compared to entities that are remunerated on a fixed return regardless of the profits (or even losses) of the overall business.
Captive premiums need to be allocated based on each individual risk and the respective beneficiaries.
Similarly, while addressing the correct premium pricing and loss reserve corridor, actuarial analysis will most likely not address the appropriate premium allocation between multiple insureds, especially if any other specific facts are present that may negate a general way of allocating premiums that may be used by the market broadly, such as number of cars or square footage of a property.
If premiums are not allocated, or not allocated correctly, deductions taken on tax returns for the premiums paid to the captive could be challenged or even disallowed. More so, certain countries explicitly prohibit deductions for premiums that at some point end up in an affiliated captive insurance company. Not fully documenting how and where premiums are allocated may generate tax controversy in those jurisdictions.
Domestic-only captives: does TP matter?
While there is higher focus on transfer pricing for multinationals, it is still relevant in domestic-only groups and their captive programs.
For many US-headquartered companies, the captive is taxed as a US taxpayer, even if it is domiciled in a foreign jurisdiction. In these cases, transfer pricing can (1) demonstrate arm’s-length behavior between the captive and insureds, (2) support risk transfer, and (3) show a captive abides by the notions of commonly accepted insurance principles.
This test is an important factor to demonstrate that the captive meets the definition of an insurance company from a US tax perspective. Transfer pricing supports the accelerated tax deductions in year one as an insurance company or when a new product is added to the captive.
In addition, many states apply transfer pricing principles under the Internal Revenue Code in their state laws. Many times, the answer at the state level may be that the captive itself is not subject to tax.
While that may be the correct answer, the impact of properly allocated premiums to each insured sometimes goes overlooked, even though that allocation may impact state tax liability.
Certain states actively audit groups with captives to ensure that those taxpayers are computing the correct amount of state tax.
How transfer pricing affects the Insurance Premium Tax
Insurance companies are subject to a variety of taxes. As captive programs focus mainly on federal taxes, some of these additional, indirect taxes may not be intuitive. One such example is IPT, which is a tax that may be levied by governments on the premium charged to an insured entity.
If premiums are not allocated, or are allocated incorrectly under transfer pricing principles, it can result in misreporting or underpayment of certain taxes, such as IPT. In certain cases, premiums for centrally purchased global coverage may be allocated through appropriately computed recharges.
Such recharges may align well with transfer pricing principles and have well-documented support on the recharge methodology.
While transfer pricing in those cases may be well documented, a liability for IPT may still exist, as certain jurisdictions request details on corporate recharges to assess whether insurance premiums have been included.
Taxes such as IPT are mainly in place to mitigate the loss of revenue that occurs when a premium is recharged to a subsidiary in a particular jurisdiction versus having the subsidiary buy coverage locally, which would result in a local insurance carrier paying tax on its profits or premiums collected.
Generally, captives (or captive owners or local insured subsidiaries) must self-assess the amount of IPT due and file a tax return in well over 30 jurisdictions that have IPT requirements. The underpayment of taxes may carry a financial and, in some cases, a reputational risk.
How Self-Procurement tax relates to TP
SPT is assessed on the insured that procures coverage directly from an affiliated insurer, such as a captive.
While different states have varying laws on SPT and how SPT applies, the general rule is that (1) SPT is based on a policy-by-policy approach, (2) SPT requires understanding the location of the home state for each policy, and (3) the home state for affiliated groups may actually vary from policy to policy.
Properly allocated premiums, taking into account transfer pricing rules and considerations noted previously, may shift the home state under a particular policy depending on specific facts and circumstances.
Conclusion
While accepted industry standards and actuarial analyses have their place in premium determination and allocation, the role of transfer pricing should not be overlooked.
As there is no one-size-fits-all approach to how to balance the three, each company needs to consider its specific facts, technical merits, and its ability to support a position that will ultimately be taken – including the efforts needed to pull together an appropriate and defensible position.
When in doubt, or help is needed, seek assistance from a competent advisor specializing in the captive insurance industry.
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The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global EY organization.
This GCP Short, produced in partnership with AXA XL, is all about Asia Pacific captives including life and non-life in their portfolio.
In a 20 minute discussion, Richard is joined by Friends of the Podcast Shiwei Jin, Head of Global Programs for APAC & Europe at AXA XL, and Juliet Kwek, Regional Director for MAXIS Global Benefits Network in Asia Pacific.
Shiwei and Juliet discuss recent life and non-life captive activity in the region, what opportunities and challenges there are for employee benefits in captives and domicile developments as well.
