GF&M’s Simpson Quoted on Small Captives in 'The Self Insurer'
Jeffrey K. Simpson, a Director at Wilmington law firm Gordon, Fournaris & Mammarella, P.A., was quoted recently as an expert source for an article on the rise of small captive insurance companies in The Self-Insurer, the official publication of the Self Insurance Institute of America (SIIA).
Simpson, whose practice focuses on the formation, regulation and governance of captive insurance companies (a form of corporate self-insurance), offered insight into current controversies over the use and alleged misuse of these structures for tax shelter purposes.
Small captive insurance companies, also known as Enterprise Risk Captives (ERCs), are set up for the purpose of covering severe, low frequency risks not typically covered by commercial insurance. But for small and midsize companies, small captives offer much more than just risk coverage—they can be a powerful financial management tool, because small captives are taxed only on investment income, not premium income.
This means that as long as these entities fulfill IRS requirements for small insurance companies (their primary business must be insurance, with risk pooled across many insureds and no more than $1.2 million in annual premium), they can potentially accumulate large amounts of income. Critics allege this income is misused for wealth transfer and tax shelter schemes.
According to Simpson, as long as small captives function primarily as risk management vehicles, their use in “facilitating certain additional financial benefits such as wealth transfer and estate planning” is not necessarily improper.
“The owners of these captives often first hear about the idea from a financial planner or investment advisor. Many of the opponents of Enterprise Risk Captives are people from traditional insurance backgrounds who are uncomfortable with… the means by which the captive owner gets educated.”
Simpson offered insight into what the future may hold for ERCs in the face of increasing scrutiny from the IRS and some state financial regulators. The industry is taking steps to ensure basic standards are met, which should lead to better regulatory and tax guidance in the near future, he said.
Most of the problems affecting small captive programs can be endemic to any size captive program, Simpson pointed out. “The fact is that ERCs are perfectly legitimate and the vast majority of them are executed carefully and with good risk management as the underpinning.”
