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Risk Management

Bad Facts Make Bad Law

One of the first things that a first-year law student learns in law school is that bad facts make bad law.  Well, the most recent example of the truth of that adage was delivered by the United States Tax Court in an opinion filed on March 10, 2021, in Caylor Land & Development, Inc., et al v. Commissioner T.C Memo. 2021-30, another victory for the IRS in a captive insurance case.  However, the facts in this case were so bad and so untethered from the typical captive insurance arrangement that it is difficult to see how this case will have any negative impact on the captive insurance industry.

Findings of Fact

The lead petitioner in the case, Caylor Land & Development, Inc. (Caylor Land), was an Arizona corporation engaged in commercial and residential real estate development.  Its owner, Rob, was the son of the founder of another general building contractor, Robert Caylor Construction Company (Caylor Construction).  Over time, Rob bought Caylor Construction from his father and also formed a number of different entities representing different construction projects.  The Tax Court found that this was not uncommon in the real estate business, where every project carries a separate risk.  The Tax Court also found that Rob ran the “empire” through Caylor Construction.

It is important to note the relationship between Caylor Construction and Caylor Land and between Caylor Land and the other members of Rob’s “empire”.  It appears that most of the revenue generated by Rob’s business ventures was concentrated in Caylor Construction.  Those funds were then distributed to the other entities through “consulting fees” paid to Caylor Land.  For example, the Tax Court found that, in 2009, Caylor Land had $1.4 million in gross revenue, of which $1.2 million were consulting fees paid by Caylor Construction.  Caylor Land then paid much of what it received from Caylor Construction to the other entities, also as “consulting fees”.  The “consulting fees” paid by Caylor Land to the other entities in Rob’s “empire” constituted a significant part of the revenue of those entities.

Why does this matter?  First, the Tax Court questioned whether the payments called “consulting fees” were really consulting fees.  There were no written agreements between any of the parties and no records of what consulting actually took place.  In addition, the entities used almost all of the “consulting fees” to pay insurance premiums.

The Captive

In 2007, Rob engaged Tribeca to form and manage a captive insurance company called Consolidated, Inc. (Consolidated).  Consolidated was incorporated under the laws of Anguilla in December, 2007.  Here is where the facts get a bit sketchy.  The Tax Court found that Caylor Construction paid insurance premiums of $1.2 million in December, 2007, which it deducted on its 2007 tax return.  It thought this unusual, because Caylor Construction had not yet provided any underwriting information to Tribeca and the actual insurance policies were not issued until sometime in 2008.  The Tax Court found this strange, because the policies were “claims-made” policies but were not issued until after the policy coverage period had ended.  In addition, it found that Caylor Construction had paid premiums of $1.2 million for, at most, ten days of coverage in 2007 and possibly for “none at all”.

What the Tax Court did not say in its opinion, but must be true, is that the policy coverage period was the calendar year.  Otherwise, if the policy coverage period were December, 2007, to December, 2008, a policy delivered in early 2008, would not have been issued after the expiration of the policy coverage period.  In addition, premiums paid in December, 2007, would not have been for ten days of coverage.

IRS Audit

The IRS audited all of the entities for the 2009 and 2010 tax years.  It denied Caylor Construction’s deduction for the “consulting fees” paid to Caylor Land.  In addition, it denied a deduction for the payments made by the other entities to Consolidated.  The cases of all taxpayers were consolidated were trial.

Since the years under audit were 2009 and 2010, whatever happened in 2007 should have been immaterial to the result in this case.  However, the Tax Court clearly was affected by what happened in 2007.  In addition, it found that this pattern repeated itself in subsequent years – premiums were paid before the policies were even priced, and the policies were not issued until after the expiration of the policy coverage period.  In addition, the Tax Court found that, while premiums were paid by all of the entities, actual policies were issued to only a small number of the Caylor entities.  If the other entities were even covered under the policies, they were covered as additional insureds.

The Tax Court’s Opinion

In the opinion, the Tax Court said that there are three issues in the case:

  1. whether the “consulting fees” paid by Caylor Construction to Caylor Land were deductible as ordinary and necessary business expenses;
  2. whether the payments to Consolidated were “insurance expenses”; and
  3. whether the IRS could impose accuracy-related penalties.
1. Consulting Fees

The Tax Court resolved this issue fairly easily.  It found that there was no consulting agreement between Caylor Construction and Caylor Land, no invoices for consulting services and no evidence that consulting services were actually provided.  As a result, the money transferred from Caylor Construction to Caylor Land was more like a distribution of profits and not an ordinary and necessary business expense.

2. Insurance

The Tax Court’s analysis of whether the payments made by the various Caylor entities to Consolidated were insurance premiums should be familiar to anyone who has read the opinions in the Avrahami, Reserve Mechanical and Syzygy cases.  In fact, the judge in the Caylor case is the same judge who decided Avrahami.

The Tax Court repeated that insurance premiums are generally tax deductible as ordinary and necessary business expenses.  However, money set aside as “a loss reserve or a form of self-insurance are not”.  So, the issue in the case was whether the amounts paid to Consolidated were insurance premiums or a loss reserve.

The Tax Court also repeated the familiar refrain that the Internal Revenue Code does not define the term “insurance”.  That has been left to case law, and the Supreme Court has said that insurance has four characteristics:

  • risk-shifting;
  • risk-distribution;
  • insurance risk; and
  • whether an arrangement looks like commonly accepted notions of insurance.

Finally, the Tax Court said that it would focus on two of those factors – risk-distribution and commonly accepted notions of insurance – as it had done in Avrahami, Reserve Mechanical and Syzygy.

a. Risk Distribution

Risk distribution depends upon the concept of the “law of large numbers”.  By accepting premiums and risk from a large number of insureds, an insurance company protects itself against the adverse experience of a small number of insureds.  In Avrahami, Reserve Mechanical and Syzygy, the captives used a reinsurance pool to establish risk distribution.  In each of those cases, the Tax Court had found that the pool was not insurance, so it could not be used to establish risk distribution.  The implication is that, if the pool had been properly managed and, as a result, had been found to be insurance, it could have been used to establish risk distribution.

However, in the Caylor case, this issue was moot.  Although Tribeca maintained an “insurance pool” and told its clients that they had to participate in the “insurance pool” in order to have adequate risk distribution, Consolidated chose to not participate in the pool.  Of all the bad facts in this case, this is perhaps the worst and most curious.  It is also the reason why this case may have little impact on the captive insurance industry as a whole.  Why would a captive insurance company make the conscious decision to forego the best tool available to distribute risk among other captives and other insureds?

Instead of participating in a reinsurance arrangement to distribute risk, Consolidated chose to rely on the fact that it was providing insurance to twelve brother and sister entities.  This argument was based on the holding of Revenue Ruling 2002-90, in which the IRS said that there would be sufficient risk distribution, if a captive provided insurance to at least twelve related entities and no entity represented less than 5% or more than 15% of the total risk insured by the captive.

Unfortunately for the petitioners, the Tax Court did not buy this argument.  First, the Tax Court said that the number of related entities is not determinative.  Instead, the issue is the number of risk exposures assumed by the captive that matters.  This position is very troubling for a couple of reasons.  First, the Tax Court relied on cases that involved captives that were not microcaptives to support its position.  These cases involved multi-national corporations and thousands of insureds.  No microcaptive could possibly satisfy that test.  Second, and perhaps, most importantly, the Tax Court completely ignored Revenue Ruling 2002-90, which is one of the few pieces of guidance that the IRS has issued in the area of captive insurance and has never been withdrawn.  If a court can overrule the stated position of the IRS, no taxpayer can be safe from persecution.

What’s even more disturbing is that the Tax Court did not even have to ignore the holding of Revenue Ruling 2002-90 in order to achieve its desired, and probably pre-determined, result.  The Tax Court found that Caylor Construction represented more than 30% of the risk assumed by Consolidated.  So, Consolidated could not satisfy the requirements of Revenue Ruling 2002-90, even if the Tax Court were to have given effect to that guidance.

b. Commonly Accepted Notions of Insurance

The Tax Court next discussed whether Consolidated was operated in accordance with the commonly accepted notions of insurance.  The Tax Court acknowledged that it did not have to reach this issue, since the failure of risk distribution would be enough to uphold the tax deficiency.  However, this did not stop the Tax Court from discussing this issue.

There are five factors that a court takes into consideration when trying to determine whether an arrangement looks like insurance:

  • whether the company was organized, operated and regulated as an insurance company;
  • whether the company is adequately capitalized;
  • whether the policies were valid and binding;
  • whether the premiums were reasonable and the result of arm’s-length bargaining; and
  • whether claims were paid.

i. Organized, Operated and Regulated

The Tax Court acknowledged that Consolidated was organized as an insurance company under the laws of Anguilla, although there was some question whether Anguilla had ever actually regulated the company.  Apparently, the taxpayer did not even introduce a copy of Consolidated’s insurance license into evidence.  However, the Tax Court found that did not matter whether Consolidated was regulated like an insurance company, because it found that Consolidated was not operated like an insurance company.

First, the Tax Court was troubled by the way in which the policies were issued.  There was expert testimony that Consolidated backed into the premiums.  According to the expert, no other insurance company priced policies as Consolidated had.  In addition, the expert testified that no other insurance company would issue a policy after the expiration of the policy coverage period, as Consolidated uniformly did.

Second, the Tax Court was troubled by the way in which Consolidated paid claims.  The Tax Court found that, over a period of four years, the insureds had submitted two claims.  In each case, Tribeca, as captive manager, had requested documentation to support the claims.  However, instead of providing such documentation, Rob simply overruled Tribeca and ordered Consolidated to pay the claims.  The Tax Court found that no insurance company would pay a claim without an adequate showing that the claim was covered by the policy.

ii. Adequately Capitalized

The Tax Court found that Consolidated met the minimum capitalization requirements of Anguilla and that is all that is required.

iii. Valid and Binding Policies

As discussed above, the Tax Court found that the policies written by Consolidated were “claims-made” policies.  This means that the policies only cover claims that occur during the policy coverage period and are reported to the insurance company during the policy coverage period or within sixty days thereafter.  However, the Tax Court also found Consolidated did not issue the policies until after the expiration of the policy coverage period.  The Tax Court found this to be abnormal.  No insurance company issues a policy after the expiration of the policy coverage period when there is no longer a risk of loss.

iv. Reasonable Premiums

The Tax Court found that the premiums were not actuarially determined.  Instead, they were “backed into” in order to add up to $1.2 million.  The biggest issue was that Tribeca did not ask for “loss runs” from the insured.  In addition, Tribeca did not review the loss history of any prior policy coverage period before renewing a policy at the same premium as before.  No insurance company would determine premiums, let alone issue a policy, without reviewing an insured’s loss history.

v. Payment of Claims

As discussed above, the Tax Court found that Consolidated’s claims procedure was abnormal and unlike any real insurance company’s.

For all of the foregoing reasons, the Tax Court found that Consolidated was not an insurance company in the commonly accepted notions of insurance.

3. Penalties

The IRS imposed accuracy-related penalties under section 6662 of the Code.  The Tax Court upheld the penalties, and this is, perhaps, the most important takeaway of the case.

Penalties can be imposed in a tax deficiency case if the taxpayer understates the amount of its taxable income by a certain percentage or if the taxpayer is negligent in asserting a tax position.  The Tax Court found that both apply in this case.

However, a taxpayer can avoid penalties if it can establish “reasonable cause” for its position.  In most cases, reasonable cause requires a taxpayer to show that it reasonably relied upon the advice of an independent tax professional.  The tax professional may not have a conflict of interest, must have knowledge and experience in the area and must have all of the facts.

The taxpayers claimed that they consulted with Tribeca, their CPA and their tax attorney before participating in the captive insurance transaction.  However, there were problems.  First, Tribeca was the captive manager and had an obvious conflict of interest.  A taxpayer cannot rely on the advice of the promoter of a transaction to establish reasonable cause.  Second, both the CPA and the tax attorney had advised the taxpayers that they were not familiar with captive insurance and that they were not comfortable with the transaction.  In addition, both testified at trial that they provided no advice to the taxpayers.

A captive insurance company is a complex undertaking.  Taxpayers are always advised to seek independent, knowledgeable advice before entering into the arrangement, if for no other reason than to make sure that they understand the nature of the transaction.  However, Caylor provides another reason to seek independent advice.  It is the only way for a taxpayer to avoid penalties.

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Press Release

Courtney Boles Appointed to Gilbert-Insured Trust Board

Courtney Boles, Captive Risk Consultant for RMC Group, was recently appointed to the Town of Gilbert Self-Insured Trust Board.

The Board is responsible for the operation of the Town of Gilbert’s self-funded medical and dental plans. The Trustees provide oversight of plan administration and financials and make recommendations to the Town Council regarding risk retention/reinsurance options and funding requirements.

Courtney Boles Headshot
Courtney Boles – Captive Risk Consultant

“I’m excited to serve on the Gilbert Self-Insured Trust Board and have an opportunity to help the Town of Gilbert provide the best Health, Dental, and Workers Compensation benefits for their employees in an efficient and cost-effective manner. The Town of Gilbert is focused on the future with a mission to Anticipate, Create, and Help People,” Courtney said. “It’s good to see the town’s approach to risk management reflects this commitment and I’m looking forward to using my experience in the self-insured space to support their goals and give back to a place I love.”

Courtney joined RMC Group’s Captive Insurance division in September 2020, and is responsible for building relationships and soliciting new business. Courtney concentrates on the Southwest United States.  However, she helps business owners with their risk throughout the entire country.

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Press Release Risk Management

Vote Now for RMC’s Captive Employees

Voting for the Captive Review Power 50 has started and runs through April 12, 2021. Anyone in the captive community can nominate individuals they believe should make the cut on the prestigious list.

We have nominated two of our RMC employees and would love for you to vote for them as well!

RMC EMPLOYEE NOMINATIONS

First, we have nominated Mark Elwell, Executive Vice President of Risk, for Captive Service Professional. Mark is responsible for new program development and overall managment of the Captive and Property & Casualty Departments.

Second, we have nominated Courtney Boles, Captive Sales Consultant, for Captive Service Professional. Courtney not only brings new captives to the table, she also manages and services her captive clients.

And lastly, we have nominated Jessica Saba, Captive Administration Manager, for One to Watch. Jessica manages the day to day operations of the captives for RMC from regulatory compliance to client engagement. She is the point of contact for all captive questions.

WHAT CAPTIVE REVIEW IS LOOKING FOR

Captive Review is looking for the best of the best in the captive insurance industry, dedicated professionals who are collegial, innovative, committed, visible, and have shown excellence over the past year.

Even during a pandemic, Mark and Jessica have been busy growing our captive department with the help of our sales team. Let’s show them our support with votes to get on this well-respected list.

Click here to vote!

Categories
Risk Management

Why Make a 953(d) Election?

There are a number of reasons why a foreign insurance company would make a so-called 953(d) election.  This article will discuss two of those reasons.

What is a 953(d) Election?

The term “953(d) election” refers to a decision made by a foreign insurance company to be taxed as a United States taxpayer.  For purposes of this discussion, a foreign insurance company is an insurance company incorporated in an off-shore jurisdiction, which is neither licensed, nor engaged in business, in the United States, and can include a captive insurance company.  Typically, a foreign insurance company would not be taxed as a United States taxpayer and would not be required to file a Form 1120-PC with the Internal Revenue Service (IRS).

For the reasons discussed below, a foreign insurance company might prefer to be taxed as a United States taxpayer.  As a result, section 953(d) of the Internal Revenue Code (Code) permits a foreign insurance company to elect to be taxed as a United States taxpayer if certain conditions are met.  Those conditions include the following:

1. The foreign corporation must be a “controlled foreign corporation” (CFC).

2. The foreign corporation would qualify under part I or part II of subchapter L of the Code, if it were a domestic corporation. This simply means that the corporation is an insurance company.

3. The foreign corporation meets the requirements set out by the IRS. The IRS has set out those requirements in Rev. Proc. 2003-47.

4. The foreign corporation makes an election to have section 953(d) apply.

What is a Controlled Foreign Corporation?

As stated above, one of the requirements for making a 953(d) election is that the foreign insurance company is a controlled foreign corporation.  The definition of a CFC is provided in section 957(a) of the Code, as modified by section (b) for insurance companies.  A CFC is any foreign insurance company if more than (i) 25% of the total combined voting power of all classes of stock entitled to vote, or (ii) 25% of the total value of the stock of such corporation, is owned by a United States person on any day during the taxable year of the corporation.

The term “person” includes a United States citizen, a domestic partnership, a domestic corporation, an estate and a trust.  Ownership refers not just to direct ownership, but also includes ownership determined by applying rules of attribution.

How Does a Foreign Insurance Company Make a 953(d) Election?

The requirements for making a 953(d) election are set forth in Rev. Proc. 2003-47, which provides that a foreign insurance company must submit a statement to the IRS of its intention to be taxed as United States taxpayer.  The statement must include a list of all United States shareholders, including the name, address, tax identification number and ownership interest of each shareholder.  The foreign insurance company must agree to update the list on an annual basis.  In addition, the foreign insurance company must agree to pay all taxes as they become due.  An acceptable form of the statement is attached to Rev. Proc. 2003-47 as Appendix A.

In addition, the foreign corporation must meet one of two additional requirements.  The first is called the asset test.  To satisfy the asset test, the foreign insurance company must have (i) a place of business within the United States and (ii) assets equal to 10% of its adjusted gross income for the base year, which are physically located in the United States.  The base year is the taxable year immediately preceding the year in which the election is filed or the year of filing for a new entity.  A foreign insurance company that does not meet the asset test will instead be required to enter into a closing agreement with the IRS and post a letter of credit in an amount equal to 10% its adjusted gross income for the base year, but not less than $75,000 or greater than $10,000,000.

The election is not effective until it has been accepted by the IRS.  However, it will be effective as of the first day of the tax year in which the election was filed.  The election remains in effect until it has been revoked.

The Shareholder of a CFC is Taxed on Subpart F Income

The first reason for a foreign insurance company to make a 953(d) election is that, without the election, certain shareholders of the foreign insurance company will be taxed on the insurance income of the corporation.  So, while a foreign insurance company, which is a CFC, may not be subject to United States income tax, its shareholders are.

Section 951(a)(1) of the Code provides that:

If a foreign corporation is a controlled foreign corporation at any time during any taxable year, every person who is a United States shareholder . . . of such corporation and who owns . . . stock in such corporation on the last day, in such year, on whichcsuch corporation is a controlled foreign corporation shall include in his gross income . . .

(A) his pro rata share . . . of the corporation’s subpart F income for such year . . .

The term “United States shareholder” is defined in section 951(b) as any person who owns 10% or more of the voting power of all classes of stock of the foreign corporation entitled to vote or 10% or more of the total value of shares of all classes of the foreign corporation.  The term “subpart F income” is defined in section 952(a)(1) as “insurance income” (as defined under section 953), and section 953(a)(1)(A) defines “insurance income” as any income in connection with the issuance of an insurance or annuity contract.  In addition, the tax is owed on subpart F income whether it is actually paid to the shareholder or not.

The shareholders of a foreign insurance company will be taxed on the gross premiums paid to the foreign insurance company, if the foreign insurance company is a controlled foreign corporation, as most captives are.  This tax is not only paid on money actually paid to the shareholders, but also on phantom income – i.e. income that is not distributed to the shareholders.  However, shareholders of a foreign insurance company, which is a CFC, will not be subject to this tax if the foreign insurance company makes a 953(d) election.  In that case, the foreign insurance company will be taxed as a United States taxpayer and not as a CFC.

A Foreign Insurance Company is Subject to the Federal Excise Tax

The second reason for a foreign insurance company to make a 953(d) election is section 4371 of the Code, which imposes an excise tax on foreign insurance companies that issue policies covering United States risks.  The tax is very straightforward.  It is a certain percentage of premiums without deductions or set offs.

For property and casualty insurance, the tax is 4 cents on each dollar, or fraction thereof, of premium paid on the policy.  For life insurance, the tax is 1 cent on each dollar, or fraction thereof, of premium paid on the policy.  The tax is also 1 cent on each dollar, or fraction thereof, of the premium paid on a policy of reinsurance.

A foreign insurance company that makes a 953(d) election is treated as a domestic corporation.  It is not taxed as a foreign corporation.  Therefore, premiums paid by a United States person to a foreign insurance company, which has made a 953(d) election, are not subject to the Federal Excise Tax.  This is a great reason for making a 953(d) election.  It means that 100% of the premiums received by the foreign insurance company, including a captive insurance company, will be available to pay claims asserted against the insurance company.  This will provide policyholders with peace of mind that the foreign insurance company will have the ability to pay claims as they become due.

Categories
Risk Management

New Jersey Supreme Court Provides Relief To Captive Insurance Company

On December 7, 2020, the New Jersey Supreme Court ruled in favor of Johnson & Johnson on its claim for a refund of insurance premium taxes.  The Supreme Court adopted the decision of the Superior Court of New Jersey Appellate Division, which had overruled a decision of the New Jersey Tax Court denying the refund.

Johnson & Johnson Formed a Captive

Johnson & Johnson (J&J) is a well-known, international pharmaceutical company headquartered in New Jersey.  In 1970, J&J formed a captive insurance company called Middlesex Assurance Company Limited (Middlesex) in Bermuda to, as the Appellate Court found, “secure broader coverage and lower the costs and fees associated with its substantial insurance needs”.  The Appellate Court further found that Middlesex was a “pure or single-parent captive”.  By the time of the lawsuit, Middlesex had been re-domiciled to Vermont.  This meant that Middlesex was authorized to do business only in Vermont and was not authorized to do business in New Jersey.  In addition, as a captive insurance company, Middlesex issued insurance coverage only to J&J.

The Different Types of Insurance Markets

There are generally two types of insurance markets.  The first is the “admitted market”, and the second is the “nonadmitted or unauthorized market”.  An admitted insurer is an insurance company licensed and authorized to do business in a particular state.  This means that it can market its products directly to a resident of the state and can deliver its policies in the state.

An unauthorized insurer is an insurance company that is not licensed in a particular state and, as a result, cannot engage in marketing activities in that state.  While an unauthorized insurer may not do business in a particular state, that does not mean that a resident of that state may not buy insurance coverage from the unauthorized insurer.

The United States Supreme Court long ago held that a person has the constitutional right to buy insurance from any company of their choosing.  Therefore, while an unauthorized insurer cannot do business in a particular state, residents of that state may still procure insurance from that unauthorized insurer.

In addition, there are two types of unauthorized insurance markets.  The first is the “surplus-lines insurance market”, and the second is the “self-procured insurance market”.  The “surplus-lines market” refers to the situation where no insurance company licensed in the state is willing to cover a particular risk.

In that case, a “surplus-lines” policy may be procured through a “surplus-lines broker”, who is licensed and regulated by the state.  The “self-procured market” refers to the situation where an insured procures insurance from an unauthorized insurer directly without the help of a surplus-lines broker.

In the J&J case, the Appellate Court held that the surplus-lines market and the self-procured market are separate and distinct.  It also found that J&J procured insurance from Middlesex without the help of a surplus-lines broker.  Therefore, the insurance coverage that J&J obtained from Middlesex was self-procured insurance.

Insurance Premium Taxes

Most states in the country impose a tax on insurance premiums.  The rates vary by state, but there are very few states that do not impose such a tax.  When the premiums are paid to an admitted carrier, the state looks to the insurance company for the payment of the tax.

When insurance is purchased through a surplus-lines broker, the state generally looks to the broker for the payment of the tax.  When the insurance is self-procured, the state generally looks to the insured for the payment of the tax.

Nonadmitted and Reinsurance Reform Act

The Nonadmitted and Reinsurance Reform Act (NRRA) is a federal statute passed as part of the Dodd-Frank legislation.  The NRRA, which became effective in 2011, provides for the reporting, payment and allocation of insurance premium taxes in connection with the purchase of unauthorized insurance.

Prior to the NRRA, the payment of insurance premium taxes was a complicated and unruly system.  Each state had its own regime and generally taxed insurance premiums covering risks located within the state.  This meant that an insured with locations in multiple states could have reporting and payment obligations in all of those states when it bought insurance in the unauthorized market.  This was a reporting and accounting nightmare.

The NRRA adopted what is known as the “home state rule”.  Under the “home state rule”, only the “home state” of an insured could impose an insurance premium tax on insurance premiums paid to an unauthorized insurer.  The NRRA further defined the term “home state” as the place where the insured has its principal place of business, or the state where the greatest percentage of premium is paid, if 100% of the risk is in a state other than where the insured has its principal place of business.  In addition, an insured’s home state could impose a tax on 100% of the premiums paid by the insured, even if the insured was insuring risks in multiple states.

The NRRA Is Not Mandatory

This brings us back to the J&J case.  As the Appellate Court noted, the NRRA does not require a state to impose a premium tax.  A premium tax can only be imposed by a state’s legislature through the enactment of a statute.  More importantly, the NRRA does not require that a state impose a tax on all premiums paid by an insured, even on those premiums for risks located out of state.  It simply authorizes a state to impose its premium tax on all premiums paid by an in-state insured.

After the enactment of the NRRA, New Jersey amended its insurance premium tax statute to conform to the NRRA.  Prior to the amendment, the New Jersey premium tax statute provided that the insurance premium tax was assessed only on risks located in New Jersey.  The amendment purported to change the insurance premium tax regime by assessing the tax on all premiums paid by a resident of New Jersey, even on premiums paid for risks located in other states.

However, the New Jersey legislature, to put it mildly, screwed up.  As stated above, surplus-lines insurance and self-procured insurance are separate and distinct.  In fact, in New Jersey, they are governed by separate sections of the New Jersey statutes.  The problem is that, when the legislature attempted to amend the premium tax statute, it only added the necessary language to the surplus-lines section.  It did not amend the section that governs the self-procured insurance premium tax.

After the amendment, J&J, as a precautionary measure, paid insurance premium tax on all premiums that it paid to Middlesex, even for risks located outside of New Jersey.  J&J then sued for a refund of taxes that it claimed it had overpaid.

The Appellate Court, in an opinion adopted by the New Jersey Supreme Court, said that it was required to apply the precise language of the statute.  It reiterated that self-procured insurance is not surplus-lines insurance.  And, when the legislature amended the stature by adding language to the surplus-lines section, but not the self-procured section, it was probably an oversight.

However, as a matter of statutory construction, a court cannot give effect to the intent of the legislature, when the language of a statute is clear and unambiguous.  Here, the self-procured section of the statute was left unchanged by the amendment, and it was clear and unambiguous.  It still provided that the insurance premium tax could only be assessed against risks located in New Jersey.

As a result, the Court had no choice but to rule that J&J had overpaid its insurance premium tax and was entitled to a refund.

The moral of the story is read a statute carefully.  Whether you are a legislator writing the law or a person subject to the law, make sure you understand what it says.  And, if you do not understand what a law provides, talk to somebody who does.

Categories
Risk Management

Captive Insurance for the Mortgage Industry

The mortgage industry is flourishing.  Low interest rates and migration out of population centers mean more people are looking for homes, which means more people are looking for mortgage loans. However, with increased business comes increased exposure. While record lending may fuel growth, it also adds risk.

Growing Risks and Exposures

The mortgage industry faces many different types of risks.  Whether a business is a lender or a loan originator, there is exposure. The pandemic has caused shutdowns, forcing many businesses to close; some permanently.  This has resulted in layoffs and job losses. The employment rate, which was recently at an all-time low, is now more than double what it was before the pandemic.

When borrowers lose their jobs there is an increased chance of a loan default. Unemployment, underemployment, and a struggling economy can be tell-tale signs that the housing market is going to suffer, if not now soon. And, as a rule of thumb when the housing market struggles, the mortgage industry suffers as well.

In some cases, a loan originator that sold the loan may be required to buy the loan back or refund commissions.  These losses go directly to the business’ bottom line and are in addition to more traditional risks, such as E&O, legal liability, employee-related claims, and reputational risk that any business may face.

A business may be able to insure against some of these risks.  However, not every risk can be covered commercially, and some insurance coverages may be prohibitively expensive.  Fortunately, there is a solution when the commercial market will not do.  And that is a captive insurance company.

A captive is an insurance company formed by a business to cover the risks and exposures of the business.  It enables a business to buy insurance that is tailored to the specific needs of the business.

Coverage Possibilities

RMC has worked with the mortgage industry for many years. We have helped mortgage companies form and manage very successful captive insurance companies.  Some of the risks that a captive can cover are:

  • Administrative Actions – fines and penalties by governing bodies
  • Collections Risk / Clawbacks – based on EPO’s and EPD’s
  • Directors & Officers – exposures for the officers of the company
  • Deductible Reimbursement – reimburse deducible layers of commercial insurance risk
  • Cyber – broad coverage
  • Loss of Key Contract – losses of revenue because of a lost contract (think Fannie/Freddie Mac)
  • Medical Buydown – layer of employee medical insurance should the company meet the requirements
  • Regulatory Change – operational or revenue losses based on regulatory changes
  • Reputational Risk – covers revenue lost due to a reputational exposure

Mixing Commercial Risk into a Captive

A captive insurance company can cover many types of standard commercial risks.  Some risks can be fully covered by the captive, instead of through the traditional commercial market.  Other risks may be better handled by a combination of a captive and a commercial insurer.

E&O, Fidelity Bonds, Professional Liability, Workers Compensation, General Liability, and Property can all be written by the captive or by a combination of a captive and commercial insurer. In some cases, it may make sense to use a fronting carrier where an admitted company is required. In other cases where an admitted carrier is required, a business can reduce premiums by increasing its deductible, and the captive can write a deductible reimbursement policy.

Taking on the Risk of Your Health Insurance

A mortgage company, like any business, has employees.  And, like any business, health care is a major expense.  Most businesses are unaware that a captive can help them reduce their healthcare costs.  By using its captive to assume some of its healthcare risks, a business can significantly reduce its overall spending while still providing its employees with first-class healthcare.

To discuss your options and to see if a captive insurance company is right for your business, contact RMC today at [email protected] or 239-298-8210.

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Risk Management

How to Go from Salesperson to Advisor with Alternative Risk Strategies

How can you become a trusted advisor to your clients providing them more value than you currently are? The answer is offering them alternative risk management strategies.

Won’t offering alternative strategies reduce my commissions? Maybe, but you could go from being a commodity salesperson who could be replaced by anyone with a lower renewal offer to a consultant who receives both commissions and consulting fees.

Hear me out…

Say you write both the Property and Casualty Insurance as well as the Employee Benefits for a manufacturer with 200 employees and $45 million in annual revenue.

Sounds like a solid account!

But in 2020, you had to explain that there’s no payout for the $3 million in business income they lost when their plant was shut down due to Covid-19 because they didn’t have direct damage to the plant.

And then in 2021, their overall renewal is going to cost 25% more due to rate increases.

Suddenly, being the agent on their insurance account doesn’t make you feel quite as secure. Particularly when you find out that their investment advisor has been talking to them about captive insurance companies for a while.

What if you had been the one to bring the captive insurance company option to them?

When the denied claim happened, what if you had taken the opportunity to explain that a captive insurance company could write contingent business income? And would pay out if there wasn’t direct physical damage.

A captive insurance company can even cover extra expenses for a manufacturing business like replacement suppliers. So, when their manufacturer in China couldn’t get parts out due to the pandemic, they would have had coverage.

As the advisor, you should always give options to your client. It will show the client that you are more than just an average advisor. It will prove to them that you are a vital team member and that you have their best interest at heart.

Before your next call, what if you came to your client with a plan to increase deductibles on their commercial insurance policies, then covered those gaps through a captive insurance company? Or with a plan to help them insure a layer of their employee benefits themselves and protect against catastrophe with stop-loss which would allow for no increase at renewal?

Then with these new plans and a newly formed a captive insurance company, you can help them understand the new data available that results from the captive. This will create better loss control and coordinating renewals each year to maximize the benefits of a blended strategy as their risk consultant. Suddenly you’ve become a hero and vital team member instead of just another salesperson.

Become the trusted advisor by partnering with RMC Group to find the best solutions for your client. To schedule a call with a RMC professional, click here.

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Risk Management

Why Your Insurance Keeps Getting More Expensive…

And What You Can Do About It

Why are the policies that you purchased last year to protect your business more expensive this year? Because the insurance market is hardening.

Okay, hardening seems an appropriate word because it is certainly harder for your business to get the insurance that it needs at an affordable cost.  But what does that nice bit of industry jargon actually mean?

It means that insurance companies are becoming more selective about what risks they will take and charging more to insure those risks.

Why is the Market Hardening?

Some reasons why are obvious. Insurance companies have had to pay out significant claims for an above-average number of wildfires, hurricanes, and now Covid-19. (Even though many of these claims were denied, it still costs the insurance company to legally defend their position.)

Other reasons are more subtle. Lower interest rates and a fluctuating stock market have impacted insurance companies’ return on investments and lowered their profitability.  Working from home has increased cyber risks and civil movements have led to claims being filed against companies for their diversity initiatives or lack thereof.

Take on Your Own Risk

However, insurance is still a lucrative industry, as the ubiquitous TV commercials, sports stadium sponsorships and high-rise buildings all attest. Especially if the risk can be well-understood and managed.

So perhaps instead of transferring all your business risk to an insurance company that is not particularly keen to take it, you should retain some of the risk yourself.

If you’re willing to increase the deductibles on your policies or self-insure a layer of your employee medical costs, the premiums an insurance company charges you are likely to go down.

You then have two options: 1) simply hold aside money for these risks or 2) create your own insurance company and formalize your role as an insurer. This is known as a captive insurance company.

Captive Insurance Benefits

Creating a captive insurance company can provide better risk management for the parent company because of increased attention, trackable data, and loss control measures. In addition, your own insurance company could invest the premiums, where normally you would lose those premiums to an insurance company, which invests them and retains the investment gains.

RMC Group can help you establish a captive insurance company.  We will do a complimentary risk review of your business and the insurance policies you currently have. This will help you decide if these options are viable for you. To schedule a call with an insurance professional, click here.

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Press Release

RMC Makes Shortlist for European Captive Review Awards 2020

RMC Group has made the shortlist for the European Captive Review Awards 2020. The European Captive Review Awards recognize and celebrate captive insurance in Europe by highlighting captive owners and service providers’ excellence and innovation.

RMC Group has been nominated for Captive Manager of the Year. This award is open to all captive management companies that have performed exceptionally well during the last 12 months. The nominees will be judged on their growth by revenue, client numbers, service offering, and client satisfaction. Judges will consider the implementation of technology, accessibility for clients, and initiatives developed.

The winners will be announced during a virtual awards ceremony on November 26, 2020.

For more information on this virtual event, CLICK HERE.

Categories
Risk Management

An Insurance Policy is a Contract

When it comes to insurance, one mistake that many people make is failing to read their policy.  Most insureds believe that they understand what their policy covers simply by the name of the policy.  For example, an auto policy covers everything car-related, and a homeowner’s policy covers everything that can happen to your home.  However, this is a big mistake.

An insurance policy is a contract between the insured and the insurance company, and, like any contract, its effect depends upon the language of the contract.  In addition, since contract interpretation is a matter of state law, the state where your policy is issued is a huge factor.  The same language in one state can have a completely different meaning in a different state.

A Business Interruption Policy Doesn’t Cover All Interruptions of Business

The need to read your policy has never been more clearly illustrated than during the Covid-19 pandemic, which has affected businesses from the hospitality sector to the travel industry to medical practices.  Whether as a result of government orders or the fear of customers to leave their homes, businesses of all types have either had to shut down completely or reduce their capacity.  As a result, businesses have lost significant revenue during this time.  Fortunately, many of these businesses have business interruption insurance policies and have asserted claims under their policies.  Unfortunately, without exception, the insurance companies issuing those policies have denied coverage.  Why?

The quick and cynical answer is that the insurance companies do not want to pay these claims.  The full extent of business loss in the American economy is not yet clear.  However, one estimate is that businesses have been losing close to $40 billion a month.  Yet, the entire property and casualty insurance industry has collected approximately $6 billion in premiums.  Clearly, the premiums will not cover the losses.  However, another reason may be that the insurance companies are simply reading the language of the policies and enforcing the policies as written.

The typical business interruption policy contains language that protects a business against the inability to operate due to loss or damage to property.  In most states, the courts have interpreted this language to require actual physical damage to a business’ building.  Without demonstrated physical damage to property, there is no coverage.

Claims Have Turned to Lawsuits

The result has been that, since the pandemic began, over 5,000 lawsuits have been filed against insurance companies.  While none has been fully adjudicated yet, we are beginning to see some results.  In most cases, an insurance company will respond to a lawsuit by filing a motion to dismiss.  A motion to dismiss challenges the sufficiency of a complaint, and, by a large margin, insurance companies are prevailing on their motions to dismiss.

In order to overcome a motion to dismiss, a business must allege that its business property was damaged in the same way that it would have been damaged by fire or flood.  This is a difficult bar to eclipse.  Most business closures have been caused by government shut-down orders, rather than actual physical damage to busines property, which prevents its use.  Some plaintiffs have tried to get around this problem by claiming that their property has been damaged by the presence of the Covid-19 virus on the premises.  This has worked but only in a small number of cases.

The reason that this claim has not been more successful is that many business interruption insurance policies contain a virus exclusion.  This virus exclusion was generally added to business interruption policies in 2006.  However, there are some business interruption insurance policies that do not contain a virus exclusion.  In those cases, the plaintiffs have been able to defeat the insurance company’s motion to dismiss.

Governmental Action

Another way in which businesses are trying to get around the “physical loss or damage” requirement is by claiming that their business interruption was caused by governmental action.  Therefore, whether their physical location was damaged is irrelevant.  The government order caused the loss of their ability to use their premises.

Again, this approach has been only marginally successful.  In a very small number of states, the courts have said that the policy’s use of the phrase “loss or damage to property” must be read to mean that “loss” and “damage” are not synonymous.  Otherwise, if they meant the same, one would be what courts call “surplusage”.  In other words, either loss or damage would be excess language without adding any real meaning to the phrase.  Courts tend to avoid surplusage.  However, this argument has worked in only a few states.  In most states, the courts have said that the typical business interruption insurance policy does not cover governmental orders, as would a regulatory change policy.

What’s an Insured To Do?

The obvious answer is – READ YOUR POLICY!  However, this is not a very satisfactory answer for a couple of reasons.  The first is that insurance policies are not pictures of clarity.  They are often ambiguous and contain confusing endorsements and exclusions.  Even a highly educated businessperson may have difficulty understanding a policy if he or she is not experienced at reading policies.  The second is that, by the time you’ve read your policy, it is often too late.

The best answer is that you should work with an experienced and knowledgeable insurance professional, like RMC, before you buy your policy.  After all, you wouldn’t sign a contract without first consulting an attorney, and an insurance policy is a contract.  Not only can your insurance advisor explain your policy’s provisions before you have a claim, a professional advisor will have access to the policies of multiple companies and can find the policy that best suits your needs.  In addition, an insurance professional can negotiate with an insurance company to obtain coverage that is not part of the standard form policy.

A second reason to work with a professional is that the professional can introduce you to innovative concepts, like a captive insurance company that may better suit your needs.  A captive insurance company is an insurance company formed by a business to insure the risks of the business.  It can work in concert with your commercial insurance, replace some or all of your commercial insurance or insure risks that are not insurable or are prohibitively expensive on the commercial market.  Because you own your captive insurance company, you control the risks that it can assume.  As a result, you can tailor its policies to cover your specific needs.  While it is too late to form a captive to insure against the Coved-19 pandemic, now is the time to plan for the next unexpected risk.