Establish a captive to augment risk operations, not to gain tax advantages

Companies should not be establishing captive insurance entities simply to capitalize on tax advantages, a number of speakers cautioned at the 7th Annual Canadian Captives & Corporate Insurance Strategies Summit, held in Toronto on June 1.
“We’d like to emphasize that we would never ask you to start a captive because it might save you tax,” said Mal Leighl, executive director of financial services and insurance for Ernst & Young LLP. “It never would.”
Certainly, tax advantages might help determine where the captive should be domiciled, but tax considerations should never be the reason for its formation, echoed conference chair Bill Morgan, managing director of Aon Insurance Managers.
“There’s a real risk service for creating and transferring risk to a captive,” added Tom Tsiopoulos, partner and head of transfer pricing at Ernst & Young LLP. “That is the point, to ask if there are any real operational benefits.”
In a case study illustrating non-tax-related reasons to form a captive, John Shelonko, vice president of risk management at Lafarge North America, said his company’s decision to form a captive helped centralize and augment its analysis of risk. Lafarge is the largest diversified supplier of construction materials in the United States and Canada.
As a result of creating a captive in B.C. in 1998, Lafarge was able to concentrate its energies on the development and implementation of loss control initiatives, thus minimizing its claims costs. This helped reduce the company’s insurance premiums at a time when the market pricing was increasing during a hard market.
One central decision the captive made was to keep “skin in the game,” Shelonko said. This meant keeping a substantial retention of risk within the captive, thus taking the company out of the higher layers of insurance. This also provided the captive with the incentive to develop its loss control measures.
By analyzing comprehensive claims data, the captive was able to make recommendations that vastly reduced the company’s exposure to workers’ compensation claims.
Shelonko noted the company’s exposure went from 1,000 claims (for 6,000 employees) in 1999 down to 165 claims (for 7,000 employees) in 2010.
Having reduced its losses thus, the company benefited from a drastic reduction in insurance premiums, despite a hardening market.