While I have a great deal of respect for Mr. Adkisson and the legal work he does, I do take umbrage with his approach to marketing--that is, using scare tactics to drive business to his firm. Reading over portions of the Riser Adkisson website, to which I link above, one could be forgiven for concluding that Mr. Adkisson believes that only his firm is competent to guide clients through the complex web of laws governing captive insurance companies, and that anyone else trying to do so is shyster.
Take, for instance, this web page discussing captives that invest in life insurance. On this page alone, the word "shady" appears twice. "Bogus" appears four times. "Sham" appears five times. "Scheme" appears ten times. "Tax shelter" appears seventeen times. And "promoter" appears twenty-one times. Unfortunately though, none of these terms are used in their narrow, legal sense (to the extent that one exists), but rather as a way of scaring the public away from any advisor but Riser Adkisson.
And, the tarring of other professionals doesn't stop with his choice use of scary words. In fact, he explicitly warns the public not to respect the considered opinion of other professionals:
"Don't be fooled by the promises of the promoters, and the dubious opinion letters of their affiliated pals (remember: Son of BOSS had some of the thickest and most detailed opinion letters of all, and it didn't help)" [hyperlink added].
Apparently, Adkisson would have the reader believe that Adkisson Riser is the only firm qualified to offer its opinion on captive insurance companies, that any opinion from any other firm is dubious--equivalent in quality and substance to those related to the Son of BOSS scandal. I don't think Mr. Adkisson would ever say such offensive things explicitly to another professional's face, but he seems to have no problem doing so by not-so-subtle implication. Very unprofessional.
Furthermore, even when we get to the substance of his website, much of of it is short on analysis and long on conclusions, and invariably those conclusions are overly broad and intentionally alarming. Sometimes, they are even incorrect. To illustrate my point, I will continue analyzing several quotes from this page discussing the advisability of captive insurance companies investing in life insurance.
Adkisson begins by noting that "[s]ubject to the tax restrictions, a captive can invest in pretty much any life insurance policy from any company, so long as there is enough cash value in the policy to meet the reserve requirements -- taking into account all the other assets of the captive." This is true, except that his implication that there are "tax restrictions" on the ability of captives to invest in life insurance is erroneous. No tax authority of which I am aware has published any restrictions or even guidelines on captives investing in life insurance.
He then asserts that if a captive invests all (or substantially all?) of its assets into life insurance, "the IRS might label the entire arrangement to be a 'sham'". First of all, the IRS doesn't have authority to conclusively designate any transaction as a "sham." It can certainly assert that any given transaction is a sham if is so desires, thereby denying the taxpayer the relevant deduction, but the taxpayer is not required to acquiesce to the IRS's characterization and retains the right to challenge the IRS's position in court. So, except for those taxpayers who rollover, it's ultimately a court that decides what is a sham and what isn't, not the IRS.
Second, the word "sham" has a limited meaning in a legal and tax context, and simply purchasing large amounts of life insurance doesn't make something a sham in the absence of significant additional facts. Thus, provided that there are are non-tax reasons for creating the captive insurance company and for it to invest in life insurance, provided that the taxpayer chose to create the captive and invest in life insurance based primarily on those non-tax reasons, and further provided that those non-tax reasons are demonstrable to the IRS (or to a court if the IRS proves unreasonable), the taxpayer need not be overly concerned about the transaction being labeled a tax sham. While investing a significant portion or even all of a captive insurance company's assets into life insurance is one fact that could tend to suggest that the captive was created merely or primarily for purpose of purchasing life insurance with tax favored dollars, such a conclusion isn't required and numerous other facts may completely undermine the assertion.
In fact, as anyone familiar with the benefits and attributes of captives and modern life insurance policies can attest, there are multiple, compelling non-tax reasons to create a captive and invest in life insurance. Both captives and life insurance existed as a popular risk protection and asset accumulation vehicles long before either enjoyed favored tax status. Perhaps in a later post I shall count the many non-tax ways that captives and life insurance benefit the public, but Adkisson's apparent ignorance of them doesn't make those who are familiar with them simple "promoters" of "tax shelters".
Next, in explaining why small physician practices allegedly can't benefit from a captive insurance company, Adkisson says the following:
The principal risk that the physician faces is medical malpractice liability. Usually, the physician doesn't want to move that coverage to the captive because (gulp!) there actually might be a claim. Plus, hospitals may require a certificate of insurance from a rated insurance company as a condition of extending hospital privileges to the physician.
So, the physician wants the big deduction for a captive, but doesn't want to give up their existing medical malpractice coverage. So what does the physician have left that will support a six-figure premium payment to a captive? Nothing!
Oh, really? Nothing?! I suppose physician's don't need administrative actions insurance to protect their practices or their labs in the event of audits by OSHA, CLIA, or other regulatory agencies? And I suppose physicians can 't benefit from business risk indemnity insurance? Or failure of computer operations and/or data restoration insurance? Or contract cancellation insurance, or kidnapping and ransom insurance, or employment practices insurance, or intellectual property insurance, or trademark/servicemark infringement insurance, or terrorism insurance, or insurance for any number of other risks that either aren't typically covered under standard third party insurance policies or which contain numerous exclusions and limitations when they are?
Of course physicians could benefit from such coverage! Purchased for risk management and asset protections reasons, each one of the types of insurance mentioned in the prior paragraph is perfectly legitimate and relevant to most any business owner, including doctors. Furthermore, by purchasing all of the types of insurance noted above, and potentially several more, it's not difficult at all for total premiums paid by a small practice physician to a captive insurance company to legitimately reach six figures, Adkisson's silly assertion to the contrary notwithstanding. Any business, including a physician's practice, that engages in comprehensive risk management and asset protection planning would be crazy not to consider the impact that such contingencies could have on its operations and plan accordingly.
So, why doesn't Mr. Adkisson mention any of these risks as appropriate forms of insurance for a physician to purchase from a captive? Well, I have no benign explanation for this oversight. Perhaps Mr. Adkisson thinks that the benefits of a captive should be reserved only for those large corporations that are his clients, and that smaller businesses (especially if they work with law firms or advisors other than his own?) are likely to just screw things up for everyone. (Normally, I would be reluctant to impute such impure motives to someone I haven't personally met, but Mr. Adkisson never hesitates to assume the worst of insurance agents and other attorneys/advisors that work in "his field", so I'm just returning the favor).
Mr. Adkisson then goes on to criticize professionals who may use "risk pools" as a means of satisfying relevant risk sharing and risk distribution rules. In this regard, he states:
To create the appearance of third-party risk, a shady captive promoter may establish a "risk pool." Each client of the promoter makes premium payments for some questionable risk to an insurance company that is owned or controlled by the promoter. The risk pool then buys reinsurance from each client's captive, thus giving the appearance that each captive is deriving at least 50% of its premiums from third-party risk.
These sorts of risk pools are a sham on several levels.
I have a few questions for Mr. Adkisson: Are there ever times when non-shady people establish risk pools? Do risk pools ever insure anything other than "questionable" risks? Are all "risk pools" shams?
The obvious answers to these questions (well, obvious to anyone who knows anything about the captive insurance industry) are as follows: Yes, yes, and no. So, why doesn't Mr. Adkisson distinguish legitimate arrangements from bogus ones rather than implying that all "risk pools" are suspect?
Finally, under the heading "Problems with Life Insurance", we finally get to what appears to be Mr. Adkisson real concern:
Real insurance companies typically buy little, if any, life insurance as an investment. Instead, they generally hold more traditional and relatively liquid investments like stocks and bonds.
Owning a cash-value life insurance policy in a captive reduces the captive’s liquidity, and thus its ability to pay claims as they arise. It's just not something that a real insurance company would purchase as its principal asset.
The fact that the IRS has never issued guidance that says that a captive insurance company cannot invest in a cash-value life insurance policy doesn’t mean that it’s not a bad idea. Captive owners have worked hard over the years to gain the IRS’s begrudging acknowledgment of the validity of legitimate captive insurance arrangements for tax purposes.
Using a captive as a device to buy cash-value life insurance with pre-tax funds makes it look much less like a bona fide insurance company, and much more like a tax shelter.
Unfortunately, as is so common in this particular article, both his premise and his conclusion are flawed. Highly regulated entities such as insurance companies and banks regularly invest huge amounts of money in life insurance. Nearly seventy percent of Fortune 1000 companies fund their non-qualified deferred compensation plan for their senior executives with life insurance.
And, life insurance doesn't necessarily materially impact an insurance company's liquidity, as Adkisson implies. Modern high cash value policies have a very modest impact on liquidity in the early years and actually greatly enhance potential liquidity in the "out years." Whether such arrangement makes sense for a given captive is determined by the captive's risk profile and expected flow of claims. And, where a captive insures primarily "black swan" types of risks, future liquidity is probably more important than short term liquidity, and life insurance may therefore be among the most appropriate investments it can make (for reasons that have little or nothing to do with taxes).
While it is true that most "real" insurance companies don't invest the vast majority of their assets into life insurance as some captives do, there are very practical reasons why that's the case, none of those reasons have anything to do with the fact that the IRS might consider it a sham if they did, and most all of those reasons don't apply in the context of a closely held captive. To illustrate the point, let's engage in a thought experiment: Assume that a publicly-traded company was structured in such a way that it was economically advisable to invest one hundred percent of its assets into life insurance. Would doing so constitute a sham? Of course not! There's simply no way that the IRS could ever make a case that an existing, publicly held company investing its assets in life insurance is a tax sham if it were otherwise economically advisable for it to do so.
Which really brings home the point: There is nothing inherently wrong with a captive investing in life insurance, and there is no IRS litmus test for how much life insurance is appropriate under a given set of circumstances. Thus, the real question is not whether or how much a captive invests in life insurance, but whether or not the whole captive structure is simply a ruse to purchase on a tax deductible basis assets that could normally only be purchased on an after-tax basis. If so, then what does it matter whether the captive invests in life insurance or something else? Either way, it's a sham! And, if not, then same question: If the captive is legitimate, what does it matter whether it invests in life insurance or something else? Either way, it's not a sham.
Thus, where the taxpayer's pure motives in creating the captive are clear and well documented, I would suggest that limiting investments in life insurance to some "small percentage" or arbitrary limit, as Adkisson suggests, is absurd if business considerations dictate otherwise. Any legitimate company should ultimately invest its assets so as to best achieve its overall business objectives and not merely to satisfy some paranoid fear that the IRS will consider a legitimate arrangement to be a fraudulent one merely because life insurance is involved.
Intrestingly, to his credit, Mr. Adkisson admits as much. At the beginning of his article and at various places throughout, he lays down the the real rules, noting that there are no limits on captives investing in life insurance. But, regrettably, he then attempts to muddy the water through scare tactics in an attempt to dissuade people from contemplating significant amounts of life insurance as an option. Why?
Well, he eventually does tell us why:
"Captive owners have worked hard over the years to gain the IRS’s begrudging acknowledgment of the validity of legitimate captive insurance arrangements for tax purposes.
Using a captive as a device to buy cash-value life insurance with pre-tax funds makes it look much less like a bona fide insurance company, and much more like a tax shelter."
In short, Mr. Adkisson makes his money creating and administering captives, presumably for larger corporate clients and not small business owners like "small practice physicians". Large companies have little to no risk of being accused of employing captives as shams, but smaller companies, especially those run by that favorite target of the IRS, doctors (gasp!); and even more those that choose to invest in another favorite target of the IRS--life insurance (gulp!)--are admitedly more likely to use captives in abusive ways. But does Adkisson attempt to distinguish legitimate arrangements from abusive ones? No!
Why? Because if the IRS finds some captives to be abusive, they may seek legislation or propose regulations that would limit the benefits of captives even to the larger companies that Adkisson serves. After all, the IRS has a well-known history of performing delicate surgery with a sledge hammer.
And, should that happen, should the IRS crack down on captives in general, then Mr. Adkisson's business would be adversely affected. As a result, his website makes clear (if only by implication) that he'd rather only "big companies" gain the benefits of captives.
So, small business owners of America, please, please, for Adkisson's sake, run from captives and their "promoters" as fast as you can! This is especially true if you're a "small practice doctor" (gasp!) being approached by a life insurance salesperson (oh, the horror!) Just know that the benefits afforded business by captive insurance companies aren't for the likes of you, and no one else is qualified to "promote" captives other than Adkisson himself. In fact, just pondering these benefits too long could subject you and your tiny business to accusations of fraud(gasp!), or of participating in a sham (gulp!), or of "promoting tax shelters" (yikes!), and this is doubly true if you ponder these arrangements without the assistance of those captive omniscients at Riser Adkisson. In that case, they may even be the ones to throw the first stone at your captive!
Adkisson's public hostility toward the use of life insurance with captives insurance companies, as noted on his website, is all the more mystifying since he personally spoke at the 2009 meeting of the Association for Advanced Life Underwriting ("AALU") and gave a presentation that included a discussion on the benefits of combining life insurance and captives in various ways. During this presentation he even spoke favorably of the particular structure with which I am most familiar. So, why does he speak so broadly negatively of life insurance and captives on his public website when he spoke so positively about it in private at AALU? Perhaps it's because his talk at AALU focused on his way of doing life insurance with captives? If so, this would be consistent with his apparent position that only he knows how these things should be done. In his mind, the rest of us are just self-interested "promoters", but Jay Adkisson is looking out for the public good!
So, now that you know Adkisson's motivations, you should also understand my own: A small but significant portion of my income results form selling life insurance policies to entities affiliated in one form or another with captives (gasp!). Yes, like Adkisson (and everyone else in the world), I am biased. The difference between me and most others, Adkisson included, is that I don't pretend otherwise.
Beware the "unbiased" advisor, for he is not! And now that all biases are on the table, I'll let the reader judge who has the better argument on this particular issue, Adkisson or myself.
Finally, now that I have vented my frustrations, I will offer my apologies to Mr. Adkisson for the tone of my criticism herein. Perhaps he might consider offering his own apology to all those dedicated, knowledgeable, professional captive advisors (attorneys, CPA's, insurance agents, insurance managers, etc.) who he has (inadvertently?) slandered by lumping them together with ignorant or dishonest "promoters" of simple "tax shelters" in his article?
DISCLOSURE: IRS regulations require me to inform you that this post is not intended or written by the me to be used (and cannot be used by you) for the purpose of avoiding penalties that may be imposed with regard to the tax consequences arising from any matters discussed in this message or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed in this message.