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TAX PLANNING AND RISK MANAGEMENT WITH CAPTIVE INSURANCE

The events of September 11, 2001 and the turbulent times we face since then have produced a heightened awareness of the need for all-risk business interruption insurance.

Executives, entrepreneurs and professionals have become acutely sensitive to the possibility that the profitability and, indeed, the very survival of their businesses might be directly affected by geo-political and ideological forces which are totally beyond their control.

The actual occurrence of violent acts of terrorism within our borders, combined with the significant possibility of chemical and biological attacks on our major population centers and the re-emergence of the threat of nuclear conflagration from fringe elements of the world community have created a significant increase in demand for an insurance product that would compensate an enterprise for lost profits resulting from the interruption or cessation of business activities for any catastrophic reason whatsoever.

Insurance premium cost is directly proportionate to the risk covered. It is therefore obvious that the premium cost of such broad all-risk business interruption coverage would be very expensive, especially since events have proven that the odds associated with the risk occurrence are no longer infinitesimal.

These premium costs face additional upward pressure as a result of the significant increase in demand for such coverage. Insurance, like any commodity, is sensitive to supply/demand pressure. An increase in demand for the product without a commensurate increase in the number of insurers available to supply that product forces the price of the product upward.

Finally, insurers have increased premium charges across-the-board since September 11, 2001 to recoup their losses resulting from that catastrophe.

The net result of these factors is that, while everybody considers all-risk business interruption insurance necessary and desirable, such insurance is beyond the reach of most small businesses and professional practices.

However, by thinking "out of the box" and expanding our analysis beyond the insurer/policyholder relationship, we may develop creative strategies involving offshore captive insurance and re-insurance entities.

Such strategies would enable the business owner and professional to "self-insure" against these risks and at the same time derive extremely significant income tax, estate tax and asset protection benefits.

The income tax benefits would be derived from the reduction of current business income taxes as a result of the deduction for significant all-risk business interruption insurance premiums, as well as the avoidance of future income tax on investment income earned by offshore entities.

The insurance premiums paid to captive entities would accumulate offshore and would be invested to compound tax-free. This accumulated fund would be available to compensate the client in the event of a future business interruption claim.(1)

Insurance assets not used to pay the client's business interruption insurance claims would ultimately be credited to the cash value of that client's offshore life insurance. The client (and/or his/her family) would have immediate access to these funds via tax-free loans against cash value.

Any cash value not repatriated in this manner would ultimately be added to the death benefits payable to the client's family upon his or her death, free of income and estate taxes.

All offshore insurance assets (and the proceeds therefrom) would be protected by statute from the claims of the client's creditors (2), as well as from the claims of the insurer's creditors (other than the client).

If successfully implemented, the strategy described herein would remove significant pre-tax client funds from U.S. tax jurisdiction, allow such funds to appreciate and compound tax-free, and return the appreciated funds to the client and his/her family free of income or estate taxes.

At the same time, this strategy would create a source of compensation for lost profits in the event of catastrophic business interruption, as well as significant life insurance benefits for the client.

At this point it is important to note that the offshore captive insurance strategy described herein is not dependant upon secrecy or non-disclosure policies of foreign jurisdictions.(3)

This strategy is fully tax-compliant, transparent and open to IRS scrutiny. It is based on an analysis of existing statutes, regulations and court decisions and is carefully designed to utilize these authorities to achieve the tax benefits and asset protection benefits specified herein.

1. Such compensation to a U.S. taxpayer would be subject to U.S. income tax.

2. Such statutory exemption exists in most offshore jurisdictions (e.g., Cayman Islands, Bermuda, Belize, Switzerland, Liechtenstein, Isle of Man), as well as in many U.S. states.

3. Most offshore jurisdictions have recently modified their policies to provide for mutual exchange of information, including financial and tax information, with the U.S. government. Such jurisdictions, however, still maintain policies of absolute secrecy with respect to non-governmental requests for financial information. The client would benefit from such policies of confidentiality in civil matters..