The Use of Captive Property and Casualty Insurance Companies for Asset Protection

Ever since the 1930’s large companies in the United States have been forming their own property and casualty insurance companies in order to reduce the premium costs charged by commercial companies and insure risks otherwise not covered by commercial companies. During the past 20 years, the costs of establishing one’s own property and casualty insurance company have come down so that middle market companies have been able to afford to use captive insurance companies to reduce their premium costs and insure risks not otherwise obtainable in the commercial markets. For example, owners of real estate use captive insurance companies to insure gaps in their existing coverage. Real estate owners have insured their deductibles, casualties that are too expensive in the commercial markets, risks where no commercial coverage is available, such as toxic mold, and non traditional risks such as a change in zoning.

Captives can be used to insulate working capital that would otherwise be exposed in the event of a bankruptcy or a creditor claim filed against the property owner. Given that any risk is eligible to be covered by a property and casualty policy, one should consider the use of a captive insurance company to hold funds needed for future operating expenses or replacement reserves. Furthermore, the property owner need not form their own captive insurance company, which has the potential for being ignored by a court in a creditor proceeding. Instead, there are third-party group captives and captive pools which are respected as independent insurance companies.

Think about a property owner with a large deductible that would otherwise be self insured. Typically, the property owner can predict a certain amount that will be paid each year under its deductibles. In addition, a property owner frequently establishes reserves, not only to cover anticipated expenses, but also for the replacement of major components, such as a furnace or air conditioning system. Think about the need to replace a roof with the passage of time. Any anticipated future cash need can be the subject of a property and casualty insurance policy. When prepaying anticipated costs in the form of property and casualty insurance premiums, these funds are then held by an independent insurance pool. If a commercial insurance company cannot be required to refund premiums to a property owner’s creditors, the same restriction should apply to a captive insurance company. In addition to risks that are anticipated, it is not unusual for a company or a property owner to insure risks they never expect to incur. These are the 100-year storm risks that in all likelihood will never occur. But, in the event that they occur, it could mean the end of the business. It is not unusual to insure risks unlikely to occur even though there is a minute possibility they will occur.

In addition, companies have risks that they do not think about insuring. Take an operating business where the future of the business is incumbent upon a key employee or a key owner. If anything happens to a key employee before retirement, it would have a negative impact on the revenues of the business. This type of risk can be insured. Typically, if nothing happened to the key employee, the insured receives a refund of the unused premiums in the pool. However, while the policy coverage is in effect, these funds remain the property of the insurance company and cannot be attached by the creditors of the insured.

Of course, the funds set aside for premiums must be reasonable in relation to the risks to be insured.

There are different kinds of captive arrangements, and the tax considerations of a captive insurance company vary. The most important factor for a captive insurance company is whether there is a viable business purpose for the use of a captive. Business reasons include reducing the amounts you would otherwise pay in premiums to commercial insurance companies, covering risks you currently self insure, covering risks for which no commercial coverage is generally available and providing for risks that are unlikely to occur but if they do occur it would be a financial disaster for the company. Once it is decided there is a viable business purpose, and the premium and coverage are actuarially supported, the next question is how to structure the captive insurance company. These considerations include forming an offshore company or a domestic company. In addition, there are income tax and estate planning factors that need to be considered. In other words, once it is decided that a captive insurance company has a viable business purpose, you then consult with your tax advisor to decide upon the most appropriate structure for your captive insurance company in order to maximize the income tax and estate tax savings.

The most important consideration when considering captives for creditor protection is to be satisfied that there are other reasons to establish the captive insurance company to hold funds that will become sheltered from creditors. In this regard, the substantial cost savings that can be achieved by captives and the tax savings generally available can give rise to the non creditor protection motive.

*Professor Jerry Hesch, Esq. is a nationally recognized tax attorney and distinguished adjunct professor of taxation at the University of Miami Graduate Tax Program and serves as outside senior tax counsel to Jeffrey M. Verdon Law Group, LLP.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group, LLP at jeff@jmvlaw.com or (800) 521-0464.

California Residents Beware: New Social Host Liability Law for Furnishing Alcohol to Minors

Previously, Section 1714(c) of the California Civil Code specified that social hosts who provide alcohol may not be held civilly liable for any damage, injury, or death resulting from that alcohol consumption. However, beginning in 2011, Section 1714 is amended to now impose civil liability against a parent, guardian, or other adult who knowingly furnishes alcoholic beverages at his or her residence to a person under 21 years of age, where the furnishing of the alcoholic beverage is found to be the proximate cause of the resulting injuries or death.

A violation of this new law will most assuredly void your homeowner’s insurance and umbrella coverage, leaving you, the homeowner, bare and without any general liability coverage. While this new law will apply in California, many other states have similar such laws or will soon be enacting such laws.

Remember, this law applies to alcohol consumption by anyone under 21 years of age, which includes college students. As a parent of two college graduates myself, my wife and I can recall our concern about alcohol consumption being present when our children entertained their “underage” friends at our home during school breaks and the summer session.

Parents: This is a serious situation and can unwittingly expose you and your wealth to extreme risk of loss in a civil lawsuit. In our practice area, we routinely witness tragic situations both for the victim and his or her family, and the homeowner at whose residence the consumption took place.

Please be extra vigilant when your teenager is home and by all means, make sure your estate planning has all available “firewalls” for maximum asset and lifestyle protection.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group, LLP at jeff@jmvlaw.com or (800) 521-0464.