Navigating from a segregated cell to a wholly owned captive: key considerations

Many organisations reach a point where when it makes sense to navigate from a segregated cell captive to a wholly owned captive. At this stage, certain factors have to be considered to aid the decision and to facilitate a smooth transition, according to panelists at a Q&A session held last week as part of CICA’s Building the Best digital education series.

Barry Cox, owner of The Cox Group and president of Warehouse Services, gave his views having completed just such a transition, with input from Justin Felker, area vice president for Gallagher Global Brokerage and Jeff Packard, assistant vice president, PMA Companies.

Packard said that from his perspective a key point in the preliminary stages is to work closely with the broker and the client to establish that they are meeting what the IRS deems to be an insurance company.

“Those are some of the things that clients have got to be concerned about,” he said. “Can they show the IRS that they are in fact, distributing risk as well as pooling risk?”

Felker agreed, adding that an important step when travelling along the path from a group captive, to a segregated cell captive, and to a fully owned pure captive, is to engage accountants and attorneys to get their legal opinions.

“Before you can make the next step, you’ve got to check a few boxes in assessing which structure might be optimal,” he said.

Asked what made his company decide to make the shift from segregated cell to pure captive, Cox highlighted the difficulty of obtaining the financial statements from the segregated cell captive and trying to comply with IRS regulations.

“You have to make that decision on your own and try to do what you believe is the right thing - and I think this has been the right thing for our business,” he said. “It definitely has been initially a more expensive path to go, but we're long-term players and we believe it's the right thing long term for our company.”

Packard added that when considering moving from a segregated cell to a pure captive, you have to look at economies of scale.

“With a rented captive, you're charging a fee to get access to someone's capital, so you in fact don't have to capitalise the captive yourself,” he said. “At a point in time it made sense for Barry's company to stay in a segregated cell; that renter percentage offset the pure captive expenses. As his company's grown, it’s become more economical to start moving towards the pure captive.”

Cox agreed, saying the segregated cell option had been was a good solution for the company for a long time.

“We just got to the point where we got to be a larger business, and trying to form our own business made a lot of sense to us,” he said.

Asked what to do about tail coverage, Cox said that his company decided to commute the tail from the segregated cell to the pure captive.

“We've always held on to our tail,” he said. “We've had those discussions about what to do with the tail and we've had some claims that have stayed open for a long time - a lot longer than we would have desired. But we held on to that tail and we've not found a solution to be able to market that or, or sell it off, or pay someone to take it.”

The conversation also covered the possibility that when exiting a cell structure, it may be wise to select a new domicile – but this needs to be considered carefully.

“What comes to mind is procurement taxes,” said Packard. “You’ve got to be aware of where the parent is versus where the captive is, and what states are going charge you a procurement tax, which can be looked at as being a penalty just because you're not doing business in that state. You’ve got to be careful those things.”