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June 17-June 30, 2015 — COLORADO REAL ESTATE JOURNAL — Page 23
Law & Accounting
A thorough risk man-
agement program is
vitally important to all
contractors. The most effective risk
management programs are run by
highly skilled professionals who
understand their company’s risk
areas, insurance market dynam-
ics, expected future trends and
available options. Contractors are
exposed to many different insur-
ance risks, including builder’s
risk, contractor professional liabil-
ity, property damage, worker’s
compensation and employment
practices liability. The Patient Pro-
tection & Affordable Care Act has
spurred many companies to con-
sider “medical stop-loss captives.”
Therefore, companies that strategi-
cally manage their insurance risk
can protect their financial strength
and reduce insurance costs.
Captive insurance companies
were first formed in the 1960s in
an effort to reduce insurance costs,
address business risk and offer
more control over the administra-
tion of insurance programs. Those
concepts still apply today. Most
large companies have used cap-
tives for many years. Today’s most
likely captive candidates are mid-
dle-market companies that want to
spread their risk, reduce insurance
costs and protect their capital base.
There are a number of factors to
consider prior to forming a captive,
including defining the insurable
risks, performinga feasibility study,
assessing risk objectives, quantify-
ing initial capitalization require-
ments, projecting future operating
costs, determining the country or
U.S. state of domicile and com-
plying with insurance licensing
requirements. The amount of the
captive’s initial capital investment
and ongoing capital requirement is
determined by the entity structure
and requirements of the country or
U.S. state of domicile. After forma-
tion, the captive must meet opera-
tional qualifications of an insur-
ance companyandcertainriskpool
qualifications
as defined by
the Internal
Revenue Ser-
vice.
Captives can
vary in size
– anywhere
from a single
contractor to50
or more com-
panies work-
ing together.
When a cap-
tive is formed,
the parent or sponsor capitalizes
a subsidiary that acts as an insur-
ance company and manages the
captive’s operations. If multiple
companies form a captive, the par-
ticipants could be part of a trade
association, in the same industry or
not related at all. A captive should
be small enough to be manageable
but large enough to achieve finan-
cial and performance targets.
Captive insurance program
advantages
• Stabilization of pricing over
time. Insurancemarket fluctuations
will have less effect, as pricing is
based on the insured’s individual
loss history.
• Tax advantages. Acurrent-year
ordinary deduction is permitted
for premiums paid to the captive.
If premiums paid to a domestic
captive do not exceed $1.2 million
and the captive makes an elec-
tion under Internal Revenue Code
Section 831(b), the premiums are
exempt from federal tax and the
captive is taxed solely on its invest-
ment income.
•Dividends from the captive are
taxed at the more favorable capi-
tal gains rates instead of ordinary
income tax rates. The 3.8 percent
net investment income tax may
apply; thus, reducing some of the
overall tax advantages.
• Ability to direct investment
options. Captive reserves and sur-
plus are invested at the direction of
the captive owner.
• Coverage customization.
• More control over claims han-
dling.
• Streamlined insurance renewal
process.
• Reduced exposure to commer-
cial insurancemarket.
• Lower markup costs from the
primary insurancemarkets.
• Reduced administrative over-
head.
• Shift of regulatory authority to
a less restrictive domicile.
Captive insurance
program disadvantages
• Capital outlay. Acaptive insur-
ance program comes with forma-
tion costs and ongoing mandatory
capitalization requirements.
• Tax regulations. The IRS has
imposed stricter definitions and
harsher penalties for noncompli-
anceunder newly emphasized IRC
Section 953(d) related to offshore
captives as well as increased scru-
tiny of domestic captives.
• Ownership of a captive may
complicate mergers and acquisi-
tions.
• Difficulty in closing entity. Lia-
bilities may remain on a captive’s
records for years.
•Administrativeduties. The cap-
tive ownermust take responsibility
for oversight.
• Volatility of the reinsurance
market. Captives will not fully
eliminate susceptibility to pricing
fluctuations.
• Mandatory formalities of run-
ning the captive like an insurance
company.
There are many factors to con-
sider related to the formation and
operation of captive insurance pro-
grams. Based on these and other
considerations, a captive may or
may not be right for your compa-
ny and should only be considered
after consulting with qualified tax
and legal counsel.s
Dennis McGuire
Partner, BKD LLP,
Bloomington, Indiana
declarations – i.e., construction
anddesignprofessionals – so long
as they are specifically intended
within the declarations.
CCIOA is modeled after
a national uniform act – the
Uniform Common Interest
Ownership Act. The Vallagio
decision may have profound
effects on similar issues on a
national level. One of the char-
acteristics of uniform acts such
as UCIOA is that the adopting
states are to look to one another
on interpretation issues with a
goal of maintaining uniformi-
ty across state lines. The clar-
ity provided by the Colorado
Court of Appeals, assuming the
Colorado Supreme Court does
not grant a request to review
and overrule it, provides much
needed guidance on a critical
issue in Colorado construction
defect law.s
Because no two clients
are ever the same.TM
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