A Unified Approach to Captive Insurance Tax Policy

By Porat, M. Moshe; Powers, Michael R. | Risk Management, September 1994 | Go to article overview

A Unified Approach to Captive Insurance Tax Policy


Porat, M. Moshe, Powers, Michael R., Risk Management


Over the past three decades, the captive insurance movement has established itself as a significant alternative to traditional insurance. Today, there are more than 3,000 captive insurers worldwide, accounting for approximately 6.5 percent of U.S. commercial property-liability insurance premiums. As captives proliferate, controversy surrounding the tax-deductibility of both premiums paid to captives and reserves established by captives continues unabated. The federal government, through law and Internal Revenue Service (IRS) regulations, remains steadfast in its determination to disallow tax deductions for risk-financing mechanisms other than traditional commercial insurance. While the federal courts have generally supported this basic policy, they have often disputed government rationales.

[CHART OMITTED]

A definitive resolution of tax policy issues for captive insurers is long overdue. To be workable, an approach to these complex issues must meet a number of criteria. First, it must be theoretically sound and intuitively appealing, as well as consistent with the government's established policy of favoring traditional insurers over alternative risk management techniques. In addition, it must be fair and reasonable to all parties, reducing incentives for abuse, litigation, and distortions of economic activity. Finally, it must provide room for partial solutions across the spectrum from no tax-deductibility to full tax-deductibility, and result in consistent solutions for all arrangements involving captives, including variations in the ownership structure and in the types of business written.

U.S. insurance tax policy has consistently favored transfers of risk to traditional insurers over alternative risk management techniques, most notably self-insurance. This bias goes back as far as the Tariff Act of 1909, and has persisted through subsequent laws up to and including the Tax Reform Act of 1986. The principal advantage given to traditional insurance over self-insurance is that traditional insurers can deduct reserve amounts established for unearned premiums and losses incurred but not yet paid (including losses incurred but not yet reported), whereas selfinsurers are afforded no such deductions. Furthermore, only insurance premiums paid to traditional insurers are tax-deductible as general business expenses.

Probably the best explanation for the government's unwillingness to grant self-insurers tax advantages similar to those of traditional insurers is the concern that self-insurance transactions are less likely to be allocatively efficient because they are not subject to the economic forces of the insurance marketplace. In other words, the government implicitly insists that, for a corporate business expense to be consistent with public policy, and therefore fully tax-deductible, the associated transaction must be allocatively efficient from the corporation's perspective.

From the government's perspective, loss reserves for self-insurance should not be taxdeductible because they involve transactions that are not subject to the economic forces of the insurance marketplace, and therefore potentially inefficient. Even if a self-insurer establishes reserves in an "arm's-length" manner (that is, by imitating the capital requirements and actuarial methodologies of traditional insurers), the potential for inefficiency remains. For example, a self-insurer may have economic incentives to manage the investment of reserves in a manner that is much different from (and possibly riskier than) that of a traditional insurer. As a practical matter, it is highly unlikely that Congress would consider granting improved tax treatment to self-insurers given the current political landscape regarding insurance issues, and concerns about the federal budget deficit. In fact, even traditional insurers have come under attack in recent years, losing some of their previous tax advantages.

The situation is complicated by the fact that two fundamental tax doctrines collide in the case of captive insurers.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

A Unified Approach to Captive Insurance Tax Policy
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.