1. New Uses and Benefits of
Captive Insurance-What,
Why and How
May 20, 2015
Philip J. Tortorich
+1.312.902.5643
philip.tortorich@kattenlaw.com
Partner
Katten Muchin Rosenman LLP
Kyle Mrotek
+1.262.402.8612
kmrotek@taa-inc.com
Consulting Actuary
The Actuarial Advantage, Inc.

2. What is a Captive Insurance Company?
• Entity which provides insurance coverage to a
related group of businesses.
• It is a true insurance company that requires an
insurance license in the designated
jurisdiction, proper accounting for reserves
and surplus, issues policies and settles claims.
• A captive generally provides property and
casualty insurance.
2

3. Basic Captive Structure
3
Captive
Insurance
Company
Operating
Business
Business
Owner
Payment of Premium
Issuance of Policies
100% 100%

4. Why Form a Captive?
4
• Improved risk management
• Profit center
• Expanded/customized coverage
• Flexibility
• Access to reinsurance
• Incentive for loss control
• Opportunity to minimize income and transfer taxation

5. 5
Source: Wilmington Trust
Financial Benefit-Sample Comparison
Five year
accumulated
benefit
 $2 million

6. Where is a Captive Formed?
6
• States to Consider for Captive Formation, include:
− Nevada
− Delaware
− Utah
− Missouri
− Vermont
− Hawaii
• Offshore Jurisdictions to Consider for Captive Formation,
include:
− Cayman Islands
− Bermuda
− British Virgin Islands
− Hong Kong

7. Where is a Captive Formed? (continued)
7
• In considering in which jurisdiction to form a captive, there are several
factors to consider, namely:
− What is the premium tax, if any?
− What assets can be considered for reserve purposes – i.e., “permitted assets”?
− How long has the jurisdiction been issuing captive licenses?
− Will the insured need a “Certificate of Insurance” for policies issued?
− What are the annual meeting requirements of the jurisdiction?
− What are the restrictions, if any, on the types of permitted investments?
− What are the fees for the initial application to obtain the insurance license?
− What are the capitalization requirements?
− What reporting is required by the captive?
− Do the principals have to meet with the Insurance Commissioner
in the jurisdiction before obtaining a license?

8. What Types of Policies Can a Captive Issue?
8
• Proper policy design is essential to the success of a captive
• Captives can offer practically all types of insurance
• In general, business owners should not replace their commercially-
purchased insurance with self-insurance except in limited
circumstances
• Rather, the captive can offer policies which protect against the
potential to pay the deductibles on the commercial insurance. This will
allow the business to increase its deductibles as high the commercial
insurer will allow – thereby lowering the cost of the commercial
insurance.
− Excess limits over commercial insurance
− Fill gaps of commercial insurance exclusions

9. 9
• Following are examples of the various types of commercial
policies that businesses can investigate:
− Antitrust & Unfair Competition
− Commercial Vehicle Insurance
− Construction and Design Defect
− Copyright Infringement
− Deceptive Trade Practices
− Directors & Officers Liability
− Employment Practices
− Environmental
− Advertising Liability
− Errors & Omissions
− Malpractice
− Performance Liability
− Structural Defects
− Title Insurance
− Trademark Infringement
− Libel & Slander
What Types of Policies Can a
Captive Issue? (continued)

10. What Types of Policies Can a
Captive Issue? (continued)
10
• In addition to rounding out the commercial coverage,
captives can also provide “softer” coverage where the
claimant will be the business itself and not a third party.
• This type of coverage is particularly attractive in a captive
setting since the result is that the overall economic family
retains the funds. However, moving the funds from the
captive back to the operating business in payment of the
claim shifts the money away from the tax-favored entity.
It is important for the business to implement risk mitigation
methods in order to limit the claims even from these
“softer” policies.

11. 11
Source: Leon Rives

12. 12
• There are many types of these “softer” policies than can be
considered by the business. Jay Adkisson does a good job of
referencing a number of these types of policies in his book “Captive
Insurance Companies”. Included in these types of polices are:
− Administrative Action
− Advertising & Marketing
− Antitrust and Unfair Comp.
− Business Credit Cover
− Business Dirty Tricks
− Business Document Forgery
− Business Extortion
− Business Interruption
− Currency Risks
− Delay Start-up
− Eminent Domain
− Financial Crime
− Force Majeur
− Foreign Operations
− Administrative Delay
− Insurance Failure
What Types of Policies Can a
Captive Issue? (continued)
− Product Tampering
− Production
Benchmarks
− Property Damage
− Trade Secrets
− Strike & Labor Unrest
− Terrorism
− Theft
− Trade Credit

13. 13
• Types of “soft” policies (continued):
− Business Reputation
− Cargo Consequential Loss
− Cash in Transit
− Commercial Crime
− Commun. Breakdown
− Computers: Dissemination
− Computers: Loss of Data
− Computers: Software
− Computers: Virus Loss
− Confiscation
− Contract Frustration
− Copyright Infringement
− Knock-Off Lost Profit
− Lawsuit Interruption
− Labor Costs
− Legal Expenses
− Lender Failure
− Loss of Key Customer
− Loss of Talent
− Machinery Breakdown
− Market Flooding
− Market Risks
− Political Risks
− Product Launches
What Types of Policies Can a
Captive Issue? (continued)
− Trade Good Will
− Patent & Trademark
Infringement
− Transit Risk
− Unfair Calling of
Guarantees
− Weather Risks

14. What are the Income Tax Benefits of
Captive Planning?
14
• Tax Benefits to Operating Businesses:
− Ability to achieve Section 162 or Section 212 deductions for the
payment of premiums to the captive.
• Tax Benefits to Captive Insurance Company:
− Ability to reduce gross income by amounts accrued for future potential
losses (i.e., reserves).
− Ability for smaller captives to elect 831(b) status which exempts all
income (other than investment income) from taxation at the captive
level.
• Tax Benefits to Owner of Captive
− Ability to monitor captive reserves and receive distributions from the
captive at capital gain rates when the reserves can no longer be
maintained. If the captive makes an 831(b) election, then
no income would be picked up by the captive other than the
investment income.

15. What is “Insurance”?
15
• In order to achieve the income tax benefits the payments must be for
“insurance” and must relate to “insurance contracts”.
• Anyone can form a captive and have the captive insure risks from
operating businesses. However, that does not necessarily mean that the
structure implemented will result in any income tax efficiencies.
• In order for the captive to provide any income tax efficiencies, the captive
must provide “insurance” under the Internal Revenue Code.
• Interestingly enough, the terms “insurance” and “insurance contract” are
not defined in the Internal Revenue Code. Rather, the IRS and Courts look
to the “definition” of insurance provided by the Supreme Court in Helvering
v. Le Gierse. Namely, that insurance has two components:
− Risk Shifting; and
− Risk Distribution

16. What is “Insurance”? (continued)
16
• Risk Shifting
− Requires that an operating business shift the risk of
loss away from itself to another entity.
− Any claim covered by the policy will not further
affect the insured once the premium is paid for
the coverage.
• Risk Distribution
− Requires that the captive distribute its risk among
several insureds.
− Works off the statistical law of large numbers.

17. What is the Case Law Regarding Captives?
17
• Humana Inc. v. C.I.R., 881 F.2d 247 (6th Cir. 1989)
• Harper Group v. C.I.R., 96 T.C. 45 (1991), aff'd, 979 F.2d 1341 (9th Cir.
1992)
• Kidde Industries, Inc. v. U.S., 40 Fed.Cl. 42 (Ct. Cl. 1997)
• Hospital Corporation of America v. C.I.R., T.C.M. 1997-482 (1997)
• United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001)

18. What are the IRS Rulings
Regarding Captives?
• Revenue Ruling 2001-31
• Revenue Ruling 2002-89 – Safe Harbor 1
• Revenue Ruling 2002-90 – Safe Harbor 2
• Revenue Ruling 2002-91
• Notice 2003-34
• Revenue Ruling 2005-40
• Revenue Ruling 2007-47
• Revenue Ruling 2008-8
• Revenue Procedure 2002-75
18

19. IRS Revenue Ruling Structure
(“Safe Harbors”)
P
R
E
M
I
U
M
S
Parent
Operating
Company
Captive
Insurance
Company
Third-Party Risk
(Purchased from
Reinsurance Companies)
$500,000
in premiums
$500,000
in premiums
100%
owner
Captive
Insurance
Company
100%
owner
Parent
Subsidiary 1
Subsidiary 2
Subsidiary 3
Subsidiary 4
Subsidiary 6
Subsidiary 7
Subsidiary 8
Subsidiary 9
Subsidiary 10
Subsidiary 11
Subsidiary 12
Subsidiary 5
* No one subsidiary having more than 15% nor less than 5% of the total premiums paid to the captive.
19

20. How is Captive Planning a
Wealth Transfer Technique?
• In the foregoing examples it was assumed that the business owner or parent
company owned the captive as a subsidiary entity.
• However, if the ownership of the captive is held by a trust for the business owner’s
family, then you can effect an effective wealth transfer with very little use of gift
tax exemption, if any.
• Many of our clients have trusts that already contain significant assets, those trusts
could use a portion of the assets to capitalize the captive.
• This would create no gift tax situation.
• If the client does not have a previously funded trust, then there are three options:
− The client can gift the necessary amount to the trust and the trust can use that
amount to fund the captive.
− The client loan assets to the trust which the trust can use to capitalize the captive.
− Finally, the client can do a part-gift / part-loan.
• In negotiating with the insurance commissioner in the jurisdiction where the
captive is formed, it may be possible to have some portion of the required
capital satisfied by a letter of credit.
20

21. How is Captive Planning a
Wealth Transfer Technique? (continued)
• Once the captive is properly funded, the trust will own the captive
and have the benefit of any of the profits generated by the captive
without gift taxation.
• The payment of premiums by the operating businesses to the captive
should not be considered to be gifts since the payments are
determined by actuaries reflecting arms-length premiums for the
coverage. It is crucial to have dependable and relatively
conservative actuaries on the team to justify the premium amounts.
• Finally, there should be no estate tax inclusion if the trust is properly
designed.
• The trust should also allocate GST-exemption to any gifts to the trust so
that the trust can be a long-term dynastic trust for future generations.
• Any gifts or allocation of GST-exemption will require the filing of a gift
tax return.
• On the next slide is a typical captive structure with wealth
transfer planning included.
21

22. Captive Structure with
Wealth Transfer Planning
Captive
Insurance
Company
Operating
Business
Business
Owner
Irrevocable
Dynasty
Trust
100% owner
Uses $200,000 gift
to capitalize captive
Depending on entire structure
may need to reinsure risks of
third parties to qualify as
insurance for tax purposes
$800,000 premiums
Insurance coverage
Note: Capitalization requirements generally run around ¼ of the anticipated initial
premiums, with this percentage going down in offfshore jurisdictions.
$200,000 gift
22

23. • Purpose
− Is a captive insurance company right for
your company?
− If yes, how to pursue optimally?
• Content
− Financial evaluation
− Operational evaluation
− Actuarial analysis
Captive Feasibility Overview
23

24. • Basic Results
− Actuarially fair premium
− Projection of loss and loss expense
Captive Feasibility
Policy Year 2015
Coverage Written Premium Ult Loss & Loss Exp
Coverage A $500,000 $325,000
Coverage B $400,000 $260,000
Coverage C $200,000 $130,000
Sum $1,100,000 $715,000
24

25. • Basic Results
− Expected Scenario Loss Payout
Captive Feasibility (continued)
Loss and Loss Expense Payout
Policy
Year
Written
Premium
Ult Loss &
Loss Exp 2015 2016 2017 2018 2019
2015 1,100,000 715,000 500,500 107,250 71,500 35,750 0
2016 1,122,000 729,300 510,510 109,395 72,930 36,465
2017 1,144,000 743,600 520,520 111,540 74,360
2018 1,167,000 758,550 530,985 113,783
2019 1,190,000 773,500 541,450
Sum 5,723,000 3,719,950 500,500 617,760 701,415 751,205 766,058
25

26. • Basic Results
− Adverse Scenario Loss Payout
Captive Feasibility (continued)
Loss and Loss Expense Payout
Policy
Year
Written
Premium
Ult Loss &
Loss Exp 2015 2016 2017 2018 2019
2015 1,100,000 715,000 500,500 107,250 71,500 35,750 0
2016 1,122,000 729,300 510,510 109,395 72,930 36,465
2017 1,144,000 743,600 520,520 111,540 74,360
2018 1,167,000 1,750,000 1,750,000 0
2019 1,190,000 773,500 541,450
Sum 5,723,000 4,711,400 500,500 617,760 701,415 1,970,220 652,275
26

27. • Additional Results
− Pro Forma Financials
− Evaluate Capitalization
Captive Feasibility (continued)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
YE '15 YE '16 YE '17 YE '18 YE '19
NPW:Surplus (Exp)
NPW:Surplus (Adv)
Res:Surplus (Exp)
Res:Surplus (Adv)
PY 2018 adverse loss
increases solvency ratios
27

28. Growth in Captive Insurance
-4%
-2%
0%
2%
4%
6%
8%
10%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Captive Counts vs US GDP
Captives
US GDP
Source: Business Insurance, World Bank
28

29. Growth in Captive Insurance
0
1000
2000
3000
4000
5000
6000
7000
8000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Number of Captive Insurers
Source: Business Insurance
29

30. CIRCULAR 230 DISCLOSURE: Pursuant to
regulations governing practice before the
Internal Revenue Service, any tax advice
contained herein is not intended or written to
be used and cannot be used by a taxpayer
for the purpose of avoiding tax penalties that
may be imposed on the taxpayer.
30