This week, we continue our series about distinguishing legitimate captive insurance arrangements from shams.
Remember, there is growing concern among regulators, the IRS, and captive insurance professionals that too many small captive insurance companies lack economic substance—that is, that they are shams constructed for the purpose of avoiding taxes rather than for real insurance and risk management reasons. While we share this concern, many of the guidelines offered up by the IRS and some captive professionals to differentiate good and bad captives (and good and bad captive advisors), are mostly useless. Most are nothing more than characterizations and are both too broad (in that they tend to suggest that some perfectly legitimate captive arrangements are shams) and too narrow (in that they fail to identify many abusive arrangements).
One mischaracterization offered up by the IRS and some in the captive industry is: “If a small or mid-size business owner is introduced to the concept of captive insurance by a wealth manager, CPA or other strategic financial advisor the motivation behind the captive arrangement should be suspect.” The implication is that the captive must be a tax-motivated transaction since outside advisors, some of whom (like CPAs) are tax professionals, “marketed” the idea to the business owner rather than the business owner, for his or her own true risk management reasons, deciding to do a captive insurance company on his or her own without any outside guidance or influence.
This implication is simply wrong.
It is fraught with large company bias, and it results from ignorance regarding how small and mid-size businesses obtain proactive financial and risk management advice. The simple reality is that, unlike Fortune 1000 companies, many small and mid-market businesses don’t have a robust and sophisticated Risk or Finance Departments. In these closely-held businesses, the individuals responsible for the research of new and advanced enterprise risk management strategies generally concern themselves with day to day business operations (accounts receivable, accounts payable, bookkeeping, etc.) rather than sophisticated and proactive financial or risk management planning.
So, where do small and mid-market businesses get the proactive planning help that they need? Historically from an independent wealth manager, an independent and proactive CPA, and/or an independent risk manager or other advisor – the very people that the IRS and certain and industry pundits would have us believe are inherently suspect marketers of “tax shelters.” In many cases, these independent advisors serve as de facto CFOs to the small and mid-market businesses that they serve.
Do we have any reason to believe that these independent advisors are any more or less motivated by taxes in recommending a captive insurance company than their Fortune 1000 peers? The same companies that have reaped the benefits of captive ownership for decades? Of course not. First, Fortune 1000 CFOs are, if anything, more highly tax motivated than the independent advisors to small business. For instance:
Burger King pursued a merger with a much smaller Canadian restaurant chain, Tim Horton’s. Keep in mind that Canada’s population is roughly 10% of the U.S. was this a case of a large company acquiring a smaller one? No! The smaller company, Tim Horton’s, was acquiring the larger one, Burger King. CNN Money described it as a “Whopper of a tax dodge,” noting the “deal” would reduce taxes paid in the U.S. by $400 million! Clearly, Burger King’s finance department earned their money. To read about Burger King’s corporate inversion scheme, CLICK HERE.
Apple’s incredibly low corporate tax rates suggests that, pound-for-pound, Apple’s lawyers and finance professionals are for more valuable than Apple’s programmers. An article in USA Today on Tuesday, May 21, 2013 noted “Apple has avoided tens of billions of dollars in U.S. taxes on its profits, according to a Senate report summary issued Monday…” The article also stated, “The California-based firm has used a web of offshore entities – including three Ireland subsidiaries… to cut some of its tax rates to 0.05%, the Senate Permanent Subcommittee on Investigations reported.” As a large corporation, Apple has scale advantages and access to a legal and financial dream team. To read about Apple’s massive tax avoidance, CLICK HERE.
And second, these independent advisors, who serve numerous small and mid-market business clients, are uniquely positioned to see the various risks that small businesses face. Talk to any of them for any length of time and you will quickly hear stories of businesses that failed as a result of litigation expenses, canceled or breached contracts, supply chain interruption, natural disasters, and a great many other risks that are true existential threats to small businesses. Helping their small business clients prepare for and protect against such risks benefits both them and their client.
In short, learning of the benefits of a captive from one’s CPA, wealth manager or independent advisor is not, by itself, evidence of some improper tax motivation. You could even argue that a strategic advisor that doesn’t have a discussion on captives is doing their business and their client’s a disservice. Rather, an improper tax motivation is evidenced by, among other things:
- Advisors recommending business owners establish captive arrangements for tax purposes with little or no attention paid to risk management
- Advisors encouraging business owners to treat a captive insurance company like a personal bank account rather than as an insurance company with potential claims obligations
- Advisors recommending that captives invest their assets in a way that does not support the liquidity and claims-paying obligations of the captive itself
Want to know how to bring the captive insurance concept to your clients?
Assurance Partners Can Help Define the Pathway
As one of the largest providers of risk management services in the Midwest, we specialize in partnering with strategic advisors to help them guide their clients through the process of determining coverages and risks that are unique to their organizations. We then translate those risks into an acceptable insurance program allowing them to obtain the protection and financial benefits that are unavailable in the traditional insurance marketplace all while strengthening your firm’s value and providing additional revenue.
Formally insuring the risks your client’s businesses face provides can provide them with significant competitive advantages like:
- A stronger business model
- Turn risk management from a cost center to a major profit center
- Superior asset protection
- Significant financial strength
- Wealth accumulation through program performance
- Unique and favorable tax advantages
The process starts with a conversation regarding our firm’s approach and the unique challenges your clients face. What significant risks do they face that are currently uninsured? How can they go about implementing an effective Enterprise Risk Management strategy to take advantage, and protect, the success of their business? What are the potential financial and strategic benefits that a captive insurance program provide to their firm? How does your firm benefit from the ERM process
Contact us to discuss how Assurance Partners can help reinforce your value as a strategic advisor.
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