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CHICAGO — Small captive insurance companies eligible for the Internal Revenue Code's 831(b) tax election have been a major factor in the pace of new captive formations in recent years, but 831(b) captive owners have to be careful to avoid running afoul of IRS guidelines, experts say.
The IRS is showing increased interest in captives lately, including a heightened focus on 831(b)s, observers say.
“The IRS has never liked captives,” said Charles J. Lavelle, partner at law firm Bingham Greenebaum Doll L.L.P. in Louisville, Ky. “They are much more active on audit these days.”
Under IRC Section 831(b), insurance companies with no more than $1.2 million in annual written premium pay no tax on their underwriting profits. Multiple insurers owned by related parties have an aggregate $1.2 million limit, according to Ernest C. Achtien, chief financial officer at Captive Resources L.L.C. in Schaumburg, Ill.
“The rules are kind of picky and you just have to watch it,” Mr. Achtien said. “First and foremost, it has to be a good insurance company,” he said. “You have to have a non-tax business purpose. You have to be transferring true insurance risk.”
The comments were made at Self-Insurance Institute of America Inc.'s Annual National Educational Conference & Expo last month in Chicago.
While the small 831(b) captives are a fast-growing segment of the captive insurance market — Mr. Achtien said he has heard anecdotally that there are 3,000 831(b) captives and others suggest the number is even greater — panelist Jeffrey K. Simpson, director at law firm Gordon, Fournaris & Mammarella P.A. in Wilmington, Del., said most regulators don't keep track of the number of captives in their domicile that make an 831(b) election.
“For the most part, nobody's really keeping track,” Mr. Simpson said. Of the regulators he's interviewed, only one said the domicile tracks the number of captives making an 831(b) election, he said.
Every regulator he spoke to said his or her domicile makes no exceptions or accommodations to attract 831(b) captives, even those whose statutes provide some relaxation of standards for small insurance companies, Mr. Simpson said.
States that do the most 831(b) business seem to be those most likely to be asked to consider less traditional captive ownership arrangements, Mr. Simpson said. His discussions with regulators showed that states that do significant 831(b) business allow the captive to be owned outside the corporate chain, such as by a trust or for the benefit of the founder's heirs, he said. Conversely, regulators in states that do not do significant 831(b) business told him they'd never been asked to consider such arrangements.
And of the regulators he discussed 831(b) issues with, only one looked closely at IRS guidance and expected captives to follow it. The others said they focus only on captives' solvency, liquidity and policyholder protection, Mr. Simpson said.
Mr. Lavelle said he thinks much of the IRS' increased attention to captives recently is an attempt to “fill in the gaps” between previous revenue rulings.
Among the frustrations for captives in trying to pass IRS muster is that, among the agency's guidelines for companies looking for insurance company treatment, is that the company take on “insurable risk” rather than “business risk,” Mr. Lavelle said.
“The really frustrating thing is they haven't defined business risk,” he said.
The IRS is also likely to interpret the absence of claims as a lack of true risk transfer to the captive, Mr. Lavelle said. “Here's what the service really doesn't like: They don't like it when you buy insurance and there are no claims,” he said. “They equate that with no risk.” He advised captive owners to make claims if a loss occurs and pay claims if they're valid.
John T. Naughton, principal at Keystone Risk Partners L.L.C. in Conshohocken, Pa., moderated the session.
SIIA's 33rd National Educational Conference & Expo drew approximately 1,600 attendees to the Sheraton Chicago Hotel & Towers Oct. 21-23. Next year's event is scheduled for Oct. 5-8 in Phoenix.
CHICAGO — Predictive modeling among workers compensation insurers is presenting a challenge to self-insured groups, who are facing off with insurers that are offering increasingly competitive pricing.