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Many of America’s largest companies were already taking advantage of the strategy, as were a number of high net-worth individuals. It is a tax savings vehicle with excellent profit potential and can also serve as an asset protection and estate-planning tool. Why is so little usable information available about it? Anyone familiar with offshore investment options is aware of offshore captive insurance but the option is quickly dismissed with the realization that one must set up a legitimate insurance company with bona fide arm’s length clients. Many investors pass it off as an option reserved for multimillion-dollar companies and very wealthy individuals. There are well-know insurance companies offshore such as Exel Insurance, Terra Nova, Partners Reinsurance and Ace Ltd. These enterprises are successful, well-managed and have not been faced with payouts for heavy losses in several years. They had average returns of 63.9% for the 12 months ended March 31, compared with 45.5% for the Standard & Poor’s 500-stock index, according to an article in the Chicago Tribune. These companies are based in Bermuda, which imposes no income taxes. Exel, is the 14th-largest insurer in the North American property and casualty market. The company, which provides liability insurance for corporations, paid only $5 million in income taxes worldwide last year on $677 million in pretax income, while many of its competitors in the United States paid an average tax rate of 40%. Although these companies are located offshore in low or no-tax jurisdictions, this is not necessary for smaller companies to enjoy similar tax benefits. According to Bruce Molnar and Fred Turner of Manchester Strategic Advisors LLC, having a domesticated offshore captive insurance company allows their clients to effectively take money from one pocket and put it into the other. As always, when dealing with legal tax strategies, it is not quite as simple as it appears, but those with taxable assets to preserve should not dismiss the concept. The strategy is not new. The IRS sanctioned tax savings for the insurance industry in the early 1900s. More recent legislation actually increased the tax benefits of an insurance company. As a result, there are more than 4,000 captive insurance companies in the US today. Currently under IRS Code adopted in 1986, an insurance company with up to $350,000 in annual premium income pays no tax on that income. The legislation was designed to encourage companies to insure unusual risks and thereby help the economy. There is also no tax on investment income set aside in case of a claim and no limit on the size of this reserve. What are the limitations for investing a reserve to maintain tax-free status? The captive insurance company can invest in anything except an active business. A tax-free transfer can also be made of appreciated assets to a domesticated foreign insurance company. When dissolving the company, one can convert ordinary income into capital gains, which is the opposite of an insurance annuity contract. Best of all for those investors who prefer to have their investment close to home, the insurance company can be licensed in offshore jurisdictions such as Bermuda or the British Virgin Islands but all investments can remain at home in the US or Canada where they can be watched. No need to take your money offshore. An offshore insurance company offers another major advantage to those who do wish to invest offshore. Your company is able to invest in funds and investments that are not available to individuals in the US due to SEC restrictions. There are almost no limits on the type of investments it can make, anywhere in the world. These investments also accrue tax-deferred as long as they are part of the insurance reserve. Why set up the insurance company offshore instead of in the US? There are two reasons. First, it is easier to set up offshore; less regulation and bureaucratic red tape. Mr. Molnar likes the British Virgin Islands due to its excellent captive insurance legislation and infrastructure. Cost is also a factor. California requires a $5 million cash bond to be posted for an insurance license. This is too expensive for most small companies. The BVI is much more affordable. Messrs. Turner and Molnar have developed techniques to allow high net-worth individuals to take advantage of the legislation and tax savings. There are some excellent asset protection aspects to the program as well. By law, insurance reserves cannot be attached by creditors launching an action against the principals since these funds have been set aside to cover potential claims. Furthermore, an offshore asset protection trust can be designated as owner of the insurance company making assets even more secure in the event of an action by creditors against the owner. The following example shows how it works for an individual requiring an aircraft for business and preferring to purchase it with before tax dollars and shelter income using the insurance company. This strategy requires one to form a legitimate insurance company with real (arms length) clients, an actual location offering actual insurance coverage. Let’s look at some options. United Parcel Service insures all parcels it delivers worldwide through its own insurance company. This has become the largest and most profitable sector of the company. Do you have a business that uses insurance in its day-to-day business? It is not necessary to insure against major catastrophic risks. Warranty coverage is another lucrative aspect of the insurance industry. Offering warranty coverage insurance to small and medium size retailers can be very profitable with minimal risk. Other possibilities include insuring returns on various types of low risk investments. Pure life insurance companies do not enjoy the tax-free status of other types of insurance corporations. However, non-life companies may write limited life insurance if 50% or less of reserves are devoted to life coverage. For those who remain skeptical of the program, there is something you should know. According to Molnar, there is no risk of being refused tax-free status by the IRS because the companies set up by his firm receive determination letters from the Internal Revenue Service before they start business. There are estate-planning possibilities as well. Although it depends of course on the individual circumstances, there are quite a few opportunities for individuals who own these insurance companies to save estate taxes when passing assets on to heirs. The cost of establishing an offshore insurance company, related structures, determination letter and getting started costs between $40,000 and $50,000 on average. There are also annual costs to maintain and run the company and pay salaries to staff. Total cost will depend on the offshore jurisdiction utilized, size of the company and other factors. It is important to note that all structures discussed in this article have been simplified. It must be stressed that great care to detail must be taken in initiating and running a domesticated offshore insurance company and related structures to insure compliance with applicable tax laws, both on-shore and offshore. |
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