The Varied Uses of Segregated Accounts Companies and Captives

June 29, 2010

Introductions

Speakers:

• P. Bruce Wright, Partner, Dewey LeBoeuf LLP

• Dennis Silvia, President, Cedar Consulting LLC

Moderator:

• Gavin P. Collery, President & COO, Alternative Group of Companies

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Setting The Stage – Environment

• Soft Market

• Interest Rates

• Inflation

• Cash/Liquidity Issues

• Capital, Collateral, Credit Availability

• Below Average ROI

3

Setting The Stage – Captive Market

• Regulatory – Bermuda, U.S., E.U.

• Incorporations Continuing

• Economic Situation Driving Strategic Review And Uses

• Strategic Focus Being:– Identifying Untapped Potential Cost-saving

Mechanisms– Increasing Retentions– Accessing Excess Capital– Considering New Uses And Lines Of

Coverage

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A Suggested Strategic Framework

• Construct Of A Risk Register

– Assets

– Liabilities

– Income

– Expenses

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• Pure Captive

• Agency Captive

• Group Captive

• Segregated Cell

• Sponsored Cell Company

• Protected Cell Company– Protected Cell– Independently Incorporated Cell

• Segregated Account

Types Of Captives / Separate Accounts

6

• Principal Issues

– Characterization Of Transaction With The Captive / Cell

– Taxation Of The Income Generated In The Captive / Cell

Structural Considerations

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Structural - Captives

• Isolate Insurance Assets And Liabilities By Individual Operating Units

• Customize Retention Levels And Insurance Terms And Conditions By Operating Unit

• Utilize Different Front Carriers By Line Of Business By Using Separate Segregated Accounts To Isolate Security To Front

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Structural - SAC’s

• SAC Can Apply To Class 1, 2 And 3 Companies

• Required Special Reinsurance Acknowledgments In The Treaty

• Participation Agreement v. Preferred Shares

• Open v. Closed Cells

• Unlimited Number Of Cells

• Section 56 Direction For Reduced Capitalization

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Structural – SAC 831(b)

• IRC Section 831(b) IRS Small Insurance Company Code

• Pending IRS Position

• Cost Effective Mechanism To Form Companies Under

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Structural - Agency Captives

• Agency Takes Risk On The Client’s Business In Segregated Account With Consideration For Disclosure

• Offer Cost Effective Segregated Accounts To Agency Clients In Support Of Single Parent Captive Initiatives

• Offer Cost Effective Segregated Accounts To Agency Clients In Support Of Group Captive Initiatives

• Model For Other Service Providers Like Law Firms, Third Party Administrators, Front Companies

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• Employee Benefits In A Cell

– SAME RULES AS CAPTIVE, I.E., Among Others . . .• Prohibited Transaction Exemption• Regulated By A Domestic Regulator

– Domestic Cell– Foreign Cell

» Branch» IRC § 953(d) Election

Possible Uses

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• Group Captive For Small Participants

– Small Participants

– Group Arrangement Established In Advance

– Tax Issues Similar To Group Captive

– Securities Issues Similar To Group Captive

Possible Uses

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• Industry Captive Center

– Single Industry With Small Participants

– Dedicated Cell Company

– Each Member Participated In A Separate Cell

– Reinsurance• Attaches At Each Cell• Cells Cede To Core Where Reinsurance Attaches

Possible Uses

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• Industry Captive Center

– Allows For• Common Commercial Program For All With Common

Risk Management/Loss Control

• Individual Retentions At Working Layer

• Loses Some Benefit Of Deduction Analysis

Possible Uses

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• Ancillary Program

– Captive Writing WC, GL, Auto Has Obtained Rating

– New Line Will Affect Rating Nov Capital/Reinsurance Proposal

– Keep Captive, And Maintain New Line In Cell

Possible Uses

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Possible Uses

• Wealth Transfer

– Background• Assumption

– Insurance Transaction– Profitable Line Of Business

• Basis– Business Owned By Generation 1 Pays

Premium To Insurer– Insurer Is Owned By Generation 2/3 (Or

Trust For Their Benefit)

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Possible Uses

• Wealth Transfer

– Background• Issues

– Application of IRC §§ 953(d) and 831(b) to Cell– If IRC § 831(b) Applies, Availability of Loss

Deduction– Capitalization of Cell

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Decision Making Factors

• Understand the Capacity and Appetite to Assume More Risk

• Determine Future Expected Losses

• Gauge Market Response

• Consider the Total Cost of Risk

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• Characterization Of Transaction

– Rev. Rul. 2008-8, 2008-1 C.B. 340• In General, A Determination Of Whether An

Arrangement Between A Person/Entity Paying "Premium" To The Cell Will Be Considered Insurance Is Based On Same Considerations As Those Taken Into Account With Respect To Captives

Tax Issues

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• Characterization Of Transaction

– Rev. Rul. 2008-8, 2008-1 C.B. 340• Thus, All Rulings, Tams, Etc., RELATING TO

DEDUCTIONS APPLY, E.G., Rev. Rul. 2002-89, 2002-90, 2002-91, 2005-40, Etc.

• How Are Cells Which Are Not Insurers To Be Treated?– Separate– Roll Up Into Core

Tax Issues

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• Characterization Of Transaction

– CCA 200849013• IRS In Viewing A Cell Aggregated All Divisions Paying

Premium Under Rev. Rul. 2005-40• Declined To Comment On The Necessity For

Homogeneity• Stated That Rules Under 2002-89 And 2005-40 Are

Applicable

Tax Issues

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• Taxation Of The Income In The Cell

– Present Concerns Re: Taxation Of The Cell• Domestic/Foreign With IRC § 953(d) Election

– As Cell Is Not A Taxpayer, Return Must Be Prepared At The PCC Level

– Tax Sharing Agreement– Tax Must Be Contributed To PCC By Each Cell– Cell With Profit Must Compensate Cell With Loss

Tax Issues

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• Taxation Of The Income In The Cell

– Present Concerns Re: Taxation Of The Cell• Foreign

– Cell Owner Who Cedes Business To Cell And Owns Preferred Stock Or Equivalent May Have To Include Subpart F Income

» Subpart F Includes Provision For Related Person Insurance Income (RPII) Unless• Less Than 20% Ownership RPII Shareholder • Less Than 20% Income Is RPII

Tax Issues

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• Taxation Of The Income In The Cell

– Present Concerns Re: Taxation Of The Cell• Foreign

– Agency Cell Does Not Generate RPII– Potential For Passive Foreign Investment Company

(PFIC) Status– Potential For Taxation As Engaged In Trade Or

Business And Branch Profits Tax

Tax Issues

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• Taxation Of The Income In The Cell– IRS Notice 2008-19, 2008-1 C.B. 366

• Proposed Treatment– In General Cell To Be Treated As A Captive Owned

By Cell "Owner"– Tax Elections Available By Reasons Of Cell's Status

As An Insurance Company Would Be Made By The Cell (Or In Certain Circumstances By The Parent Of The Consolidated Group And Not By Protected Cell Company

» IRC § 953(d)» IRC § 953(c)(3)(c)» IRC § 831(b)

Tax Issues

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• Taxation Of The Income In The Cell– IRS Notice 2008-19, 2008-1 C.B. 366

• Proposed Treatment– Cell, If Subject To U.S. Tax, Would Need To Apply

For An EIN– Activities Of Cells Would Be Disregarded In

Determining Status Of PCC As An Insurance Company

» Note PCC Elections Under IRC § 953(d)» Note Cell Elections Under IRC § 953(d)» Engaged In A U.S. Trade Or Business» Status As An Insurance Company/Passive

Foreign Investment Company

Tax Issues

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• Taxation Of The Income In The Cell

– IRS Notice 2008-19, 2008-1 C.B. 366• Proposed Treatment

– PCC Would Not Take Into Account Any Item Of Income, Deduction, Reserve Or Credit With Respect To A Cell

– Treatment Of Non-insurance Cell– Comments Requested (May, 2008)– Future (?)

Tax Issues

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• Taxation Of The Income In The Cell

– IRS Notice 2008-15, 2008-1 C.B. 366• Transitional Rules

– Issues Relating To Untaxed Earnings And Profits– IRC § 953(d) Election

Tax Issues

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