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  • Nick Jackson

831(b) captives protect businesses better than 'commercial market' during pandemic

In the past, it was said the IRS held the position that micro-captives were tax havens for creative business leaders, but advocates (and more than 70,000 savvy business-owning users) of the structure say they provide the perfect vehicles for covering business losses/continued risk during the pandemic - much better, in fact, than traditional and commercial markets. One subject matter expert states 'the commercial market has so spectacularly failed to provide risk coverage during the pandemic' and 'this would be a great time to have your own Reinsurance structure' (Captive International Reports).

For several years, the Internal Revenue Service (IRS) has been 'turning over rocks' looking for bad apple abusers in the micro-captive—aka 831(b)—industry. It has pursued a number of captives through the courts, securing victories against Avrahami in 2017 and Reserve Mechanical Corp in 2018. Part of the IRS case against micro-captives, and a key point on which the Avrahami case was decided, was that they wrote coverages for years but no claims were made against them. Good captive managers stay away from clients which send up red flags with arguable policies and zero claim histories.

When the COVID-19 pandemic hit, advocates of the 831(b) structure were quick to seize on this point. A captive could have written pandemic coverage for decades without any claims being made until 2020, the argument goes. Few would argue this invalidates this coverage as real insurance.

Co-Architect of Insurance Specialties, Robert Ferguson, says: “Now that we are nearly one year into the pandemic, resulting dynamics have proved many of the arguments against small captives wrong: small companies do face existential risks and they have a right to place claims on these very real business interruptions just like large company risk management techniques. Within actuarial reports we commission on behalf of each client, we are seeing business interruption (via pandemic or global terrorism event) fairly regularly as a line item policy.” As businesses and re/insurers grapple with COVID-19, they are recognizing pandemic risk is often excluded from most commercial coverages leaving many businesses that thought they had coverage through business interruption policies with no claim. What’s more, “even stricter pandemic exclusions are likely to come”, says Ferguson. The nimbleness and flexibility of small captives, combined with the natural synergy with their underlying insureds, position captives as optimal vehicles for the handling of current risks and positioning company(s) again future risks. Ferguson argues that innovation in the insurance industry has long been led by captives and that they will play a vital role in how businesses manage their pandemic risk, regardless of how the insurance company may elect to be taxed.

Upon serving 400+ insured over a decade in this space, Ferguson shares specific BEST PRACTICES recommendations to business leaders looking to adopt this powerful and flexible business tool dating back to President Ronald Reagan's second term (1986) in accordance with the Tax Reform Act:

1) Small and mid-market businesses should look to employ 831(b) captives as legitimate insurance structures FIRST (while realizing there are substantial benefits in asset protection and tax-advantaged premiums)

2) Shop around with regard to trusts, trustees and trust agreements (they are NOT required despite assertive propaganda in the marketplace); not all captive managers are created equally 3) There can be significant differences in cost structures; consider seeking a partner which offers a flat fee and does not bury dozens of small fees, premiums and administrative tack-ons on top of the ceding fee

4) Select a partner which can help serve your organization with subject-matter turnkey service. This can be in the areas of loan structures, investments, year-end tax filing and corporate accounting 5) Using micro-captives to write coverage for pandemic risk will require business owners and captive managers to work in unison to develop coverages that meet the needs of small and medium sized businesses. This coverage has to be affordable and provide some significant measure of mitigation when such an event occurs

To learn more about setting up a captive insurance company, contact us today. At Reinsurance Specialties, we help businesses leaders mitigate business risks, adjudicate claims, protect assets and build wealth through tax-advantaged premium.

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