IBA Announces Formation of  Group Captive Insurance Pool 


PAUL W. FREEMAN, EXECUTIVE VICE PRESIDENT, INDIANA BANKERS ASSOCIATION

After several years of research and development, the Indiana Bankers Association is pleased to announce the formation of its first group captive insurance company pool.

What is a captive insurance company?

A captive is an insurance company that insures the risks of its parent company. It is owned by the parent—in our case, by a bank holding company. The bank holding company insures a part of its risks with its captive company.

The captive may reinsure some or all of its risks, or may retain the risks. There are several benefits to a captive, but the primary goal is either to retain the profit that would have been made by an outside third-party insurance company, or to provide coverage where otherwise unavailable.

What types of insurance can a captive provide?

A captive insurance company can provide virtually any type of insurance, as long as the laws of the domicile allow that line of business to be underwritten. Types of insurance can include: directors and officers liability, bankers’ professional liability, fiduciary liability, employ-ment practices liability, property dam-age, workplace violence and crime.

Does the captive replace current insurance?

The IBA model is designed to overlay a bank’s current commercial insurance program, without disturbing the existing enterprise risk management plan. The captive plugs gaps in the current policies, rather than replace existing insurance.

However, due to rising insurance rates, the captive does provide the opportunity to explore higher deductible policies. In these instances, the cover-age provided by the captive can be structured to take higher deductibles into account.

Are there tax advantages?

Captives, like all insurance companies, have tax rules that allow them benefits not available to other companies. A company (e.g., BHC) owning a captive normally receives an income tax deduction for the payments it makes to the captive as an ordinary and necessary business expense. The captive receives the funds, pays its operating expenses, and then deducts the allowable amounts of reserves it invests.

If a claim is made, the reserves are used to pay such claims. In fact the Internal Revenue Code allows a “small property and casualty insurance company” to not pay any income tax on the receipt of premium income up to $1.2 million, creating a potential annual permanent tax reduction up to $450,000.

What constitutes a captive pool?

The Internal Revenue Service has specific requirements regarding the amount of risk shifting and risk distribution a captive must have in order to be treated as an insurance company for federal tax purposes and to permit the tax deductibility of all premiums paid to the captive by its affiliated insureds. These IRS requirements establish the minimum acceptable level of unrelated risks which a captive must have, as measured by a percentage of its premiums and/or by its number of insureds.

By participating in the IBA group captive insurance pool, individual bank captives achieve the critical risk shifting and risk distribution required by the IRS. Each participant in the pool agrees to share in the homogeneous unrelated risks of the pool.

Are there other benefits of the pool model?

Captive insurance is complex. It addresses income tax law, insurance law and bank regulation, making it hazardous for the unwary. In response, the IBA has assembled a team of professionals familiar with the structure and operation of captives, plus with an intimate knowledge of financial institutions. The IBA team includes:
  • Crowe Horwath LLP is one of the largest public accounting and consulting firms in the United States. It will provide IBA pool members with implementation consulting, followed by captive accounting and tax and insurance audit after formation.
  • KeyState Captive Management LLC offers a variety of services to community banks, including Nevada investment subsidiary services. It provides captive insurance company management services.
  • Merlinos & Associates Inc. is one of the largest independent property and casualty actuarial consulting firms in the country. The company prepares the required annual reserve certification.
  • Arthur J. Gallagher & Co., one of the world’s largest insurance brokerage firms, is serving as the risk manager.
The IBA team has developed a turnkey process to facilitate participants’ formation of a captive insurance company. This process includes: a feasibility study, actuarial analysis, domicile selection and application submission, legal formation, and capitalization and licensing.

What role does the IBA play?

  • The IBA Insurance Agency, an IBA affiliate, is serving as pool manager.
    The IBA Insurance Agency:
  • Establishes the minimum requirements for participation in the pool;
  • Manages and enforces pool requirements, and ensures that minimum standards are enforced; Provides final approval for annual renewal of the participants in the pool, based on satisfactory renewal applications and underwriting procedures;
  • Develops, implements and manages policies and procedures for withdrawal and non-renewal of participants;
  • Promulgates retention limits for shared risk, as determined by the risk manager and actuary;
  • Ensures that the captive manager pays all claims of the pool;
  • Reviews and supervises the completion of all annual compliance items for the captives;
  • Assists with annual accounting audits required by the captives.
The concept of a captive pool is not new, nor is the role of pool manager. However it is unique for a pool manager to have a membership relationship with pool participants. As an advocate for its members, the IBA has a vested interest in the success of pool participants.
 

Does a captive make sense for every institution?

The cost of creating and maintaining a captive is a consideration. Professional and management fees represent ongoing expenses. The financial benefits of a captive increase, as the institution comes closer to the $1.2 million premium exclusion.

Premiums are calculated based on he risks being assumed, creating an interac-tive relationship between the size of an institution and the premiums able to be sheltered in a captive. Institutions greater than $300 million in assets typically are prospects for this structure.

What’s next?

The first IBA group captive insurance pool is already full. IBA currently is working on a second pool, with membership subject to underwriting and the identification of homogeneous risks. The second pool should be operational by year-end.

For more information about participating in an IBA group captive insurance pool, please contact Paul Freeman at (317) 387-9380, or by e-mail at: pfreeman@indianabankers.org.


About the Author

 

Paul W. Freeman is executive vice president of the Indiana Bankers Associa-tion. He joined the IBA as director of member services in 1987, prior to which he was employed for four years with the Risk Management Associa-tion, Philadelphia, and for nine years with Bank One, Indiana, NA. Freeman is past chairman of the Indiana Council for Economic Education and past president of the Indiana Society of Association Executives, which honored him as Association Professional of the Year in 2006. A certified association executive, he has served as an instructor for the American Institute of Banking. He earned bachelor’s and MBA degrees from Butler University and is a graduate of the Institutes for Organizational Management at the University of Delaware. Freeman can be reached at (317)-387-9380, e-mail: pfreeman@indianabankers.org.



ABOUT THE KEYSTATE COMPANIES

The KeyState Companies has been serving community banks for over 20 years and presently serves over 190 financial institutions and over 210 corporations worldwide. Our services in-clude Asset & Liability Consulting, Captive Insurance Company Management, Municipal Bond Credit Reviews, and Bank Portfolio Advisory Services (through our affiliate, KeyState Advisory, LLC, a registered investment advisory firm). KeyState’s experienced team of investment officers, consultants and analysts work hand-in-hand with a bank’s executive team and their tax, legal, and accounting/audit advisors to provide bottom line solutions.