I generally discourage the direct purchase of life insurance by an 831(b) captive, as it’s a red flag that can attract the attention of regulators at the state and federal level, suggesting that the captive serves more of a tax shelter purpose than a legitimate risk mitigation need. Also, life insurance has limited liquidity and other characteristics that make it less than ideal in an industry that may demand a quick call on reserves. Instead, I usually counsel that life insurance be purchased through a downstream investment subsidiary after reserve and liquidity issues have been met.
But my cautious view isn’t the only one. There’s an interesting discussion on LinkedIn going to the fundamentals of the issue. It’s worth keeping tabs on. Cheers.
A new case in the US 8th Circuit Court of Appeals, Best Buy Stores, L.P. v. Benderson-Wainberg Assoc., L.P., ___ F.3d ____, 2012 WL 539794 (8th Cir. (Minn.), Feb. 21, 2012 (case link at bottom of this post), illustrates again the difference between self-insurance and true insurance. It has nothing to do with the pros or cons of captives or their uses or abuses; it has to do with the stupidity of companies who think they understand what “self-insurance” means.
Best Buy rented a number of retail locations from a real estate developer, who in turn was obligated to provide property and casualty insurance for the common areas under terms of the lease. The developers obtained a high deductible policy, and passed on the costs of that policy plus a charge for “self-insurance” for the retained deductible to Best Buy, which Best Buy paid under protest. (At a later point the developer formed a couple of captives for the deductible, but that wasn’t a factor in the case and can be ignored.) Best Buy sued, claiming that the developer had breached its obligation to obtain insurance under the lease, and that the self-insurance wasn’t true “insurance” within the meaning of the law. The court agreed.
“Self-insurance” in the sense of retained risk is not “insurance” in any legal sense, which is what the lessor in this case was obligated to provide under the lease.
Hat tip to Jay Adkisson for bringing this to my attention.
Best Buy Case
Estate planning has long been a potential ancillary benefit of establishing a captive insurance company in situations where the insured company is owned by a family or a small group. Nonetheless, the primary rationale for establishing the captive in the first place must be sound, namely the insurance benefit and/or cost savings to be gained by the insured. Put another way, if the captive is established with the primary intent of serving as a tax shelter, it runs the risk of attracting the unwanted scrutiny of regulators at the state and federal level. The reader should bear that in mind when reading this article on using captives as part of tax planning for hedge fund managers, which contains advice that ordinarily is best given orally and in the context described above!
Here’s a new article in the Wall Street Journal concerning inconsistent standards in reporting capital reserves among European insurers. As always, caveat emptor!
Here’s a short piece from today’s Crain’s New York Business explaining why Hurricane Irene will only be a speed bump on the way to higher profits for insurance companies. In short: losses paid out today mean higher premiums tomorrow.
The life settlement industry scored a major victory in California this week in the case of Lincoln Life and Annuity Co. of NY v. Berck, as Trustee of the Jack Teren Insurance Trust, when the California Court of Appeals, in a 2-1 ruling, reversed a lower court’s ruling and held that the sale of a beneficial interest in an irrevocable life insurance trust to an investor shortly after the issuance of a policy was not a violation of California’s insurable interest statute even though the sale may have been contemplated at the time the policy was applied for. The California law has since been changed. I tip my hat to my wonderful litigation counsel, Steve Sklaver, Ryan Kirkpatrick and Matt Berry of Susman Godfrey LLP.
This echoes the decision of the New York Court of Appeals in its decision in the Kramer litigation this past November, and continues the recent streak of victories the life settlement industries has had in recent months.
The New Jersey Captive Insurance Association has penned a response to the recent New York Times article that described a potential abuse in the use of captive insurance companies. The NJCIA’s article describes the efforts of the recent financial reform bills, notably the Dodd-Frank Act, to bring back to the United States the booming off-shore captive insurance industry, so that U.S. tax coffers and employers could have the benefit of the dollars that would otherwise flow to foreign countries. While bolstering the case for the growth for the U.S. captive industry, it leaves open the question of whether the particular practice described in the New York Times article — insurance companies establishing their own captive insurance companies — amounts to an abuse. That, I think, is a legitimate question, but far removed from the core purpose and benefit of captives in general.
