For those businesses and practitioners found uncompliant with IRS standards, the consequences are severe and could include understatement and negligence penalties, as well as potential unwinding of the captive formation and loss of important tax benefits.
Some captive managers offer their clients the opportunity to participate in "risk pools" that exist solely to give the false impression to the IRS that their captives are involved in insuring 50% or more third-party risks. In fact, these risk pools have no real risk, few or no claims, and are marketed to clients that there will be few or no claims and the captive client is assured that more than 80% of the premiums paid into such pools will ultimately be returned to the owner of the captive.
The IRS is aware of bogus risk pools and has started investigating them. Bogus risk pools have been identified in St. Lucia, St. Kitts, the British Virgin Islands and elsewhere. Bogus risk pools have also been identified in certain so-called rent-a-captive arrangements aimed at small businesses that cannot afford their own captives.
ReplyDeleteRegardless of which decision a business owner is making, there will always be some level of risk involved in each component of the leadership cycle. In fact, being able to accurately gauge the risk versus reward aspects of a given strategic move or overhaul is what generally separates the decision-makers who succeed in sustaining profitable operations over time and those that do not.
When speaking about captive insurance, there are risks involved, as would be the case with any other deployment or investment decision, but it is a bit different. The most common risk that businesses will have to remember is that this type of insurance will put the control back in their hands, and if they do not use that power wisely, the consequences can be relatively negative.
With Great Power Comes Great Responsibility
The whole point of launching a captive insurance program is to cover risks and better handle the financial and administrative duties therein. If a business owner is simply not prepared to manage this type of control, or if the internal knowledge is lacking and no external support has been provisioned, the chances of the program running like a well-oiled machine are slim.
For example, let’s say a smaller manufacturer that does not have a wealth of knowledge or resources in the accounting and HR departments decides to take on a captive. If the program is not being accurately tracked and managed right from the start, specifically by individuals who know exactly how to handle the tax- and administrative-related aspects, oversight can be hindered.
When oversight is hindered for a process that is so closely monitored and regulated by federal and state officials, the manufacturer will be taking on several dangerous risks. For one, tax season can be a nightmare, as not tracking and reporting the various aspects of insurance coverage will often lead to noncompliance with the law, as well as the sanctions that come shortly thereafter.
Additionally, the manufacturer might begin to see problems with the actual delivery of coverage and administration, leading to poor employee engagement, slow turnarounds on care, and other problems.
Remember, though, this example will only occur when the company went somewhat blindly into the captive arrangement, rather than taking a guided approach.
Mitigating the Risks
First and foremost, all organizations considering the use of captive insurance must first understand their internal workings and what they are capable of handling. If it is a smaller operation and there are not qualified staff members who can adequately manage the program, leaders must recognize this and push to get the necessary support.
Luckily, captive insurance continues to mature in the market, and businesses of all sizes can easily acquire all of the guidance and strategic support they need through several avenues.
If you are interested in captive insurance and all of the benefits it comes with, or want to know exactly what you will need for the initial deployment and long-term management, consider
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