Stewart Feldman | Capstone Associated Services

Stewart Feldman, CEO and general counsel at Capstone Associated Services, explains how the company’s structure helps it to thrive in the captive market

How does Capstone handle legislative and regulatory changes affecting the captive industry including the PATH Act and the transaction of interest designation?

For Capstone to vet a new issue, we consistently conduct internal group meetings with chartered property casualty underwriters (CPCU), chartered public accountants (CPA), administers, underwriters, joined perhaps by a claims processor, and certainly by both corporate and tax lawyers specialising in captive work. This is where the problem is examined, and a solution is designed. We don’t wait for a challenge years later. We have taken this approach on dozens of occasions over the last twenty years. Effective captive planning requires a team of advisors, with each member having part of the necessary skill set to design and implement the overall range of solutions, which are then presented to the client for the ultimate decision.

For example, Capstone and its clients were faced with the Form 8886 compliance and the restructuring of many captives to meet the “diversification” requirements of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) over the last two years. These were two major, unexpected projects for us, coming at the same time, which our team timely addressed. Over the years we’ve built the team that can handle these curve balls. A captive management firm must be staffed adequately to address these challenges.

We recognise the importance of taking responsibility for and coordinating all aspects of captive planning to ensure its coherency and success. Planning that backs up on the client down the road is not a path worth taking, and planning that leaves major aspects of it to the client, which are likely never to be carried out, is to be avoided.

How has Capstone organised its staff to provide its broad range of services? How did Capstone fare with The PATH Act and the new IRS filing requirements of form 8886?

We’ve brought additional resources to bear to monitor the rigorousness of our work which we continue to improve. Unsurprisingly, we’ve done a better job on our 200th captive than we did on our first in 1998. Over the last two years, we’ve added a fourth tax and a third corporate lawyer to our team. These experienced professionals each have a minimum of a decade of experience. Additionally, we’ve added two underwriters to our team bringing our CPCU head count to six. Our team members’ broad expertise and long-term experience in working together is the reason for our success in examinations.

To this end, since Capstone’s 1998 beginning, we’ve assembled a team of increasing depth to ensure the planning is done properly with Capstone taking the lead. Just as in medicine, the surgeon is the captain of the operating room team and takes responsibility for the surgical outcome. The surgeon must assemble and manage the team. Leaving the patient the responsibility of orchestrating arrangements for the anesthesiologist, the surgical nurse or post-operative care would an approach that is doomed to fail. A positive outcome for captive planning without a responsible and capable captive team is unimaginable.

We now employ six CPCUs with over 150 years of experience at the likes of Aon, Marsh, Johnson & Higgins, major international corporations (GM, HJ Heinz, Kinder Morgan, Servisair, Coach USA), major insurers (AIG and Liberty Mutual) and trade association sponsored captives. Our stable of tax lawyers is bolstered by corporate and financing lawyers and litigators with coverage experience, and three of our lawyers have a graduate business or masters in tax degrees.

Additionally, six of our staff have earned their CPA designation, including both Chuck Earls, Capstone’s president for 18 years, and Jeff Carlson, who is stepping into that position. This is the team that we think is needed to run an insurance company. And if you look to the commercial markets, this is the range of skills that you’d find running a commercial insurer.

What are your thoughts on 831(b) captive managers that have arguably tarnished the captive industry’s reputation?

Firstly, I don’t think this is a question limited to 831(b) captives. Rather, the ‘captive manager’ problem spans the full range of Section 501(c)(15), 831(a) and 831(b) captives. There are ‘captive managers’ in the industry that fit the mould of offering clerical and administrative services while disclaiming most of the range of work needed to successfully carry out the planning. The nomenclature of ‘captive manager’ is inappropriately used by these service providers.

For example, I’m aware of a bank that offered ‘captive management services’ which are best summarised, after reading through their agreements and seeing their work, as being clerical and administrative in nature. The bank offered to serve as little more than ‘mailboxes’ for the captive in the chosen domicile. The bank called its services ‘captive management’ – at least until the bank’s senior management figured out what was going on and exited the business.

In another instance, two unrelated organisations, run by lawyers who lost their licenses to practice, established ‘captive management’ operations where the many critical components of a successful captive programme were left to the client to ferret out for itself. This also was called ‘captive management’.

The industry, or maybe the regulators, must establish minimum standards of services and competency to use the moniker ‘captive management’ to avoid what is now a misleading industry term.

Currently, there is a widespread misunderstanding intentionally created by ‘captive managers’ themselves in implying that they are taking on an overall ‘management’ role when in fact in the fine print, the captive manager is disclaiming responsibility for legal (corporate and financing), state and federal tax, underwriting and claims management. What’s left is inappropriately being called ‘captive management.’

Do you believe mid-market businesses will continue to adopt captive insurance planning, despite continued IRS pushback?

I can’t recall a year, including both 2008 to 2009 and 2017, where we haven’t experienced net growth. This is not to say that the PATH Act and Notice 8886 didn’t affect us. Our lawyers spent a year restructuring many of our client’s captives to comply with the disingenuously called “diversification” requirements of the PATH Act. The upside, however, is that our clients can now satisfy a broader range of their risk mitigation through captives, given the increase of the annual cap to $2.3 million as of January.

The role of our business development team–which includes three CPCUs and one CPA, each with more than 25 years experience–is to educate prospective clients on how captive planning fits into their businesses. New business follows from education. Given that captive planning under each of the three applicable Internal Revenue Code provisions is statutory in nature–that is, the planning is black letter law–captive or alternative risk planning is not something that a business owner needs to shy away from.

You’ve been outspoken on cell captives. In your opinion, what are the pitfalls of cell captive arrangements?

In theory cell arrangements–whether under a series limited liability company (LLC), protected cells, segmented cell or any one of the other similar arrangements–should work. In practice, they should be considered with great caution.

In evaluating the appropriateness of a cell arrangement, the first question to be addressed is “why to pursue a cell in the first place?” The usual answer is to save on fees and capitalisation. In practice, the savings are disproportionately retained by the sponsors with limited savings passed on to the client. If the client is so concerned with fees, perhaps the business is not a good candidate for any type of captive planning.

It is short-sighted to put millions of dollars into captive planning and then to be concerned with the relatively small savings–usually $10,000 plus/minus (pre-tax) per year–offered by a cell arrangement versus a traditional standalone captive. For these savings, the client is at risk of the service provider not maintaining the integrity of the separateness of the cells, putting at risk the client’s millions for the losses of others. Any risk/reward analysis would conclude that a cell is a bad choice and the audit risk is magnified as is now evident from a review of the US Tax Court docket.

As to the capitalisation, if the core’s capital is not at risk to support the individual cells, which is often the case, support is lent to the argument that the captive is under-capitalised. Indeed, according to tax regulations, each cell must stand on its own to qualify as an insurance company for federal tax purposes.

Another basic concern is that if the prospective client is not able to afford the capitalisation, then perhaps the annual premium, likely $500,000 to $2 million, will be a stretch for the client. Additionally, we’ve seen cell arrangements used to entice $50,000 to $100,000 in annual premiums which seems unusually low for the planning called for in a captive. Undoubtedly, the frictional costs of even minimal planning outweigh the benefit.

To cap off our concerns, what we have seen in practice are documents and captive operations that do not support the separateness of the cells and which will fail any serious legal challenge. We see clients who have unknowingly ceded to the core or sponsor voting rights over their cell and signature authority over bank and investment accounts.

This is poor judgment all around. There certainly are unique situations where a cell arrangement is a good fit. However, these are few and far between. Cell arrangements are overused and a problem is waiting to happen.