S1:E21 – Protected Cell Captive Insurance 101
Season 1

 
 
00:00 /
 
1X

If you’re a captive manager, CFO, insurance broker, controller, or in risk management then you may have heard about protected cell captive insurance companies. But what exactly are they? On this episode of “It Figures,” CRI Partners Scott Bailey and Steven Lorady introduce the concept of protected cell captive entities, detail the pros and cons of utilizing one, and other high-level facets of this type of insurance company.


 

Intro:

From Carr, Riggs & Ingram, this is It Figures: The CRI podcast, an accounting, advisory, and industry focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Scott Bailey:

Hello, this is Scott Bailey from Carr, Riggs & Ingram. I’m a partner in the Raleigh, North Carolina office, specializing in insurance, manufacturing, and construction with a primary focus in captive insurance. And, I’m here with Steven Lorady.

Steven Lorady:

Hello, I’m Steven Lorady, I’m a partner in the Nashville office for Carr, Riggs & Ingram and also have a specialty focus in our captive insurance and alternative risk management group.

Scott Bailey:

And, Steven and I wanted to chat a little bit today about a set of captive structures called protected cell captives. We wanted to talk through some of the benefits, a few of the drawbacks, how they’re structured, who can use them, just tackle some basic questions. So, if we want to start from the top, Steven, could you give us a little background into what protected cell captives are?

Steven Lorady:

Yeah, absolutely. So, at the most basic sense, a protected cell captive structure is a type of captive insurance company that allows for segregated accounts. And, really what that means is that you can have one licensed and capitalized insurance company that you can use to set up separate accounts that really act as their own insurance companies within that, that structure. So, you can have one licensed entity with two insurance companies, one insurance company, really, a hundred or more operating insurance companies all with under that same license and structure.

Scott Bailey:

Okay. So, basically you’ve kind of got almost like a nested set of companies all operating on that one insurance license?

Steven Lorady:

Absolutely.

Scott Bailey:

That’s pretty cool. So, are these typically structured as C corporations or what’s the typical formation structure?

Steven Lorady:

You see some that are incorporated cell structures and you also have some that are set up under an LLC structure. It really just depends, a lot of the ways from an operational standpoint, it really is going to function the same. Either way you do have different levels of segregation depending on the structure. And, there are some nuances as far as moving the money or getting money out of the cell, but really whether you do a corporation or LLC from an operational sense, you’d be looking at a similar function.

Scott Bailey:

Great. So, it sounds like these offer a lot of different benefits that are kind of unique to this type of captive. So, it seems like the flexibility of this structure would be a tremendous benefit?

Steven Lorady:

It really is. And, really where that comes in as is where we see a lot of the series structures form. As you really have, you can have a sponsor say a captive manager or broker basically sponsor the core and capitalize that. And, then they can set up these segregated cells for their clientele underneath that core, which really lowers your cost of entry or cost of formation for that cap.

And, the flexibility really comes in at the fact that you can have as little or as many cells under that same capital requirement. So, there’s a lot of… It’s very easy to expand or contract the program underneath the series.

Scott Bailey:

And, as you say, there seem to be some cost benefits to this structure too.

Steven Lorady:

Absolutely. Absolutely. And, that really comes in at one from the upfront capital again, as I mentioned earlier, you can have one capital base at the core and that can be utilized to satisfy that capital requirement for each cell. If you want to form a smaller cap the program, but don’t want to pay in the 250 or more in your capital requirement, you could start one of these with really none and just rely on the capital of the core assume that’s capitalized and set up properly.

And, it also allows for some economies of scale when you’re looking at the audit services or actuarial service that are able to kind of bundle those and look at. I mean, you still have to look at each of these is around separate companies, but the cost structure is a little bit lower, same with the management fee for the companies.

Scott Bailey:

Gotcha. Gotcha. And, with that flexibility and cost, it seems like it’d be pretty simple to bring cells in or as programs into sort of let those go into roll off. But, the captive program continues on. Does that sound right?

Steven Lorady:

Absolutely. Absolutely. We also see some, where maybe the program isn’t large enough to do their own standalone captive at first and so they will form under a series structure, but then as that program matures and grows and they find new opportunities and coverage lines, they may get to the point where it makes more sense for them to spin off as their own standalone captive program.

And, that, from what we’ve seen has been relatively easy to do, is to really pull out of that cell series and then relicense and then capitalize your own standalone captive. So, very easy from that standpoint as well.

Scott Bailey:

So, there seemed to be a lot of these benefits. Flexibility, cost, and a very flexible cost structure, the ability to kind of expand and contract as needed. And, that there’s a little bit more just seems to be overall more flexible as a structure. What are some of the drawbacks to these?

Steven Lorady:

Some of that is depending on how it’s set up and structured, you can have a little bit less control of your captive program, because you are going to be tied in to the sponsor of that core to a certain degree. And, a lot of these, the cores or the sponsors, may charge fees to the cells for operating under their…

Scott Bailey:

Using their license really.

Steven Lorady:

Exactly, exactly. And, in some cases there can be tax implications. If you want to move funds between the cells, if you have a couple of different cells set up rather than putting them all into one stand alone captive.

Scott Bailey:

So, basically there, if you own multiple cells within a captive and you’re trying to move funds between them, there’s the potential for double taxation there?

Steven Lorady:

Yes, you can. Yeah. If you’re having to dividend or pull money out of one sale of a capital loss and another one, for example, you could have some tax implications with moves like that. But, overall from what we’ve seen, I mean, the benefits typically far outweigh the cons for smaller programs that don’t quite have the volume to do their own stand alone program.

Scott Bailey:

Definitely. They sound like a real easy entry solution for companies interested in captives. Who do we see setting up a protected cell captives or series LLCs?

Steven Lorady:

A lot of the captive management firms or the insurance brokers will sponsor the series and put the capital up. And, that allows them to really lower the barrier of entry for their client base into the captive program. So, we see brokers and capital managers doing it a lot. We also have, so, it’s really across the board, like the one that comes to my mind right now is that we work with a fairly large general contractor and they actually set up a series structure and they set up different cells ensure the different operating segments within their holding company, their portfolio of companies.

And, they’ve actually used that as a way to provide equity compensation to some of the executives for that company without having to give them ownership in the main operating company. So, there’s a lot of different things you can do with these programs.

Scott Bailey:

Right. And, so what other types of risks are we mainly seeing in these? I know we’ve seen some medical stop loss, what else are you seeing?

Steven Lorady:

I mean, really the risks are across the board. I mean, any kind of risks that you can look at from a self insurance stamp standpoint or wanting to do a high deductible program and put that lower deductible onto the captive that can be used for these. I mean they’re really not limited to any kind of specific coverages. I mean, I think to answer your original question, some of the more common ones I’ve seen are everything from enterprise risk coverages to subcontract default. Insurance, as you mentioned, the medical malpractice. We’ve seen some using medical stop loss for self-insured employer health plans. Workers’ compensation, it’s really kind of limitless from a coverage standpoint, as long as it fits into that general captive model.

Scott Bailey:

Right, right. So, and kind of to round it out a little bit, what do you see as some of the tax implications for these? Because, I know that’s always seems to be a concern when we’re creating new companies related to other companies. What are your thoughts there?

Steven Lorady:

Yeah. I mean, I think the tax implications, I think an important thing to know is that each of these segregated accounts within a series will be taxed as its own separate company. So, each will file its own tax return. They will file a 120 PC under the insurance taxation standards, assuming that they meet the requirements for that. So, you can have some benefits from that if they fall into that structure. Or even if they don’t meet those requirements and their taxes are normal insurance company, you can still look at receiving deductions on the parent company for the premiums paid in, and then the captives can deduct a large percentage of their loss reserves before they pay those claims.

Whereas if they don’t have it through a capital structure like this, the operating company would have to wait until those are paid to realize the benefits from any kind of self insured plan. Obviously with anything like that, I mean, you do have… To get the money, once you have the money into the captive, that would have to be paid out typically through a dividend or a similar transaction like that, where you have some potential for double taxation as these all of them were taxed as a corporation. And, so you do have to be mindful of that and kind of know what your plan is with the captive program, as far as how to build that with the capital that’s in it, or look at what’s this going to look like when I pull the money out of the captive and do I have any negative consequences?

Scott Bailey:

So, like any of our captive programs, kind of the key things are to make sure that there’s a strategy. Make sure that the focus is absolutely and always on risk and risk management. And, just to make sure that there’s a very active management of the activities in these protected cell captives.

Do protected cell captives require separate audits for all the different sales or can they file one audit report or do they file separate compliance statements? How does that work?

Steven Lorady:

It really depends on the domicile that they are located in. Most domiciles will allow for one combined audit that will cover all of the entities and have one set of financial statements. But, most domiciles within those financial statements will require are combining schedule where you detail it out, cell by cell. And, typically really the audit approach is we would have to audit each of those as if they are their own standalone company. So, while we can do one report with it, as far as the procedures for the audit doesn’t really change from that standpoint.

And, as far as from a regulatory reporting standpoints, all the domiciles are going to look at each cell as a regulated entity. So, they’re really going to be getting the same oversight as if they were a standalone program.

Scott Bailey:

Great, great. Any final thoughts?

Steven Lorady:

I think the biggest thing with the cell series is really just making sure you get plugged in with the proper professionals on the planning and feasibility side before you move forward. I mean, you definitely want to have an actuary who is familiar with cell series and captive programs to price out your policies and make sure that it’s going to work from a feasibility stand point and have a good captive manager and CPA and attorney in their as well and really get them involved.

On the front end to see does it really make sense? Is this the right program structure and is it just feasible from a cost standpoint based on what you’re trying to achieve with your risk management goals.

Scott Bailey:

Great. And, thanks, Steven, and thanks to everyone listening, just as a final note here, CRI is available to help with any of your captive insurance questions. Please feel free to reach out to us.

Thanks, Steven.

Steven Lorady:

Thank you.

Outro:

If you want more CRI insights or are interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures: The CRI podcast. You can subscribe to It Figures on iTunes, Spotify, or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.