The outcome from the COVID-19 pandemic highlights the role of captives as a risk mitigation tool, which Capstone Association Services says conflicts with the Internal Revenue Service’s (IRS) universal rejection of statutory-based captive insurance arrangements formed under various longstanding Internal Revenue Code provisions.
In the Mechanical Reserve decision, Capstone explained that the US Tax Court adopted the IRS’s position, “not recognising why a manufacturing facility physically located in the country's largest superfund site would need pollution liability insurance, which no commercial carrier would write”.
According to Capstone, the current strategy of the IRS “is inflicting a deluge on the tax court of hundreds of docketed cases so as to cause the court to throw up its hands and clear its docket by finding that ‘no captive is a good captive’, notwithstanding congressionally authorised tax provisions, all with little regard to existing law”.
It noted that under the “same misguided logic”, business interruption insurance providing for coverage of losses in the face of a government-imposed shutdown would be similarly dismissed.
Capstone said: “Four weeks ago, the IRS’s retort would have been that this is “unimaginable” and not a “real risk.”
Capstone suggested that the “fallacy of the IRS positions hoisted upon the tax court, unfortunately, becomes clear with the current pandemic and the resulting wholesale bankruptcy of broad swaths of mid-market businesses – restaurants, hotels, service companies, etc.”.
Many of the risks faced by businesses during the COVID-19 pandemic would have been covered under a well-designed captive insurance programme, Capstone explained, given the “lack of availability” of these coverages from commercial carriers.
Capstone said: “The usual heart of a captive’s risk mitigation programme is broadly-written policies that can respond to loss exposures not available from commercial policies.”
It noted that a captive with broadly-written business interruption and loss of services policies enables a business to respond to a crisis – like the current pandemic – as opposed to businesses folding their tents and ceasing operations.
Capstone concluded: “While it is too late for businesses facing catastrophic losses in the current crisis, especially given the IRS campaign to administratively write out of existence statutory-based insurance programmes, having a captive insurer is a vital risk management tool that helps businesses weather crises. This is why captives are ubiquitous among larger companies.”
