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More than 50 years after captive pioneer Fred Reiss formed the first captive management firm in Bermuda, the policyholder-owned facilities are going strong and set to keep growing, which is good news for policyholders of all sizes. Captives have long been used by large companies to retain the working layers of risk, cover tough-to-place risks, improve risk management controls and gain direct access to the reinsurance market, among other things. Now, as we show in our special report starting on page 15, more midsize and smaller companies are seeing the advantages.
With the total number of captives worldwide increasing 7.1% in 2014 to 6,876, while rates for commercial coverage in many cases are flat or falling, it's clear that the vehicles are an ever-increasingly popular and effective alternative risk transfer mechanism.
And captives have become even more attractive with recent court victories and regulatory changes.
Legal victories for captive owners in the Rent-a-Center and Securitas cases last year will mean that captive owners have more flexibility when structuring their captives to maximize tax efficiencies. The rulings broadened the definition of “risk distribution” to include a large number of risks rather than a large number of policyholders, as the IRS had contended.
The victories will mean that more captive owners should be able to take tax deductions for the premiums they pay to their captives. While captives provide much more than just tax efficiencies, those tax breaks are an attraction for policyholders.
On the regulatory front, the Department of Labor recently gave another boost to captives by reinstituting its fast-track ExPro procedure for approving the funding of employee benefits risks through a captive. ExPro approval means that final approval covering benefits can be granted in three months or less.
But the outlook is not all bright. The IRS is clearly suspicious of some captive structures. Last month, the agency added 831(b) captives to its Dirty Dozen list of “tax scams.” The sometimes controversial microcaptives have been a source of growth for several U.S. domiciles, and it is in the domiciles' own interests that they do all they can to make sure 831(b)s, which are legitimate risk management tools for smaller companies, are not used as tax avoidance schemes.