Sean King

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Knoxville, Tennessee, United States

Sunday, October 2, 2011

Jay Adkisson's AALU Presentation on Captives: Res Ipsa Loquitur

Last weekend I offered an extensive critique of Jay Adkisson's marketing tactics, including a detailed refutation of many of the assertions made in his recent post that was picked up by Forbes.

This weekend I want to further expand my critique by documenting just how disingenuous and hypocritical many of Jay's criticisms of other captive professionals really are. Consider, for instance, the following criticisms that Jay lobs at certain captive insurance companies and their "promoters" in the Forbes article:

Like most tax shelters, there are actually real and bona fide group captives and cell captives, etc., that are legitimately used by businesses as property-casualty risk management tools, but we’re not talking about those. Instead, we are talking about the proliferation of those types of entities to be misused as something other than a real risk management tool, and instead primarily as a tax shelter. With the bad deals we are discussing, the main reason that people get interested in them and use them is to save taxes, not for insurance. That’s the first bright red flag too.

Very importantly, the scam deals involve situations where a bunch of people who have absolutely no relation to one another, except for the desire to save taxes, are thrown together into the same deal. The promoter needs to do this to try to save administrative fees and keep the costs of the shelter down. Thus, this is one way to distinguish the scam deals from the completely legitimate deals; the legitimate arrangements are known as “pure captives” and occur where businesses form their own captive insurance companies that they alone own and control and which underwrites only the insurance risks of their own businesses (and which follow the established IRS guidelines for such companies).

By whatever name the promoter calls the deal, whether “group captive” or “cell captive” or “ICC”, etc., the base shelter concept is the same:

Your business will pay a large insurance premium (which, amazingly, will be the same amount as the deduction that you desire) for some sort of insurance against a risk that is probably never to occur, such as terrorism insurance for a business in Tennessee. Would you normally buy that insurance or pay premiums at the amount they want you to pay? Of course not — that’s why it is a shelter and not a real insurance deal.

Your business will then take a deduction in 2011, but the idea will be that in some later year either your business or you will get your money back either by what is known as a “premium refund” (or maybe a “dividend” if the particular arrangement you have chosen is a cell captive arrangement).


And he says:

Note to file: If somebody ever uses the terms “captive” and “life insurance” in the same sentence, run! Unless you have a burning desire for the IRS to act as your proctologist, that is.


And he continues:

There are myriad problems with these arrangements and easy reasons why they will blow up in your face:

* The purpose of the arrangement was not truly insurance, but instead tax savings, and thus there is no true economic purpose.
* The premiums paid bear no relationship to the true cost of the insurance (even if some actuary signs off on it — one can find an actuary to sign off on pretty much anything, including tidal-wave insurance for a Nebraska business in one actual deal).
* The arrangement is pre-designed so that the premiums are returned somehow to the participant, meaning that the entire arrangement was a sham from the get-go.
* The arrangement violates all sorts of IRS rules relating to risk-shifting and risk-distribution, even if the promoters swear on a stack of IRS Code Books that the deal is compliant.
* Some arrangements for getting the money back on a tax-favored basis pass the line beyond a mere shelter and are just criminal tax fraud.


So, in fairness to Jay, and taking the above quotes in context, let's compile a quick list of those things that he implies are red flags--i.e., things that are indicia of tax scams or fraud:

1) Multi-owner captives where those owners are unrelated (i.e., "legitimate" deals are apparently "pure captives" with a single owner or related owners);

2) Captives where tax planning is a primary objective (this, he says, is a "bright red flag");

3) Arrangements where the amount of insurance purchased is driven by tax planning or investment considerations rather than the true amount of insurance one "needs";

4) Arrangements where the captive insures low-risk things like "terrorism insurance in Tennessee";

5) Arrangements where you would never agree to pay a third party a similar amount for the same coverage (i.e., captives that are used to simply insure risks that one already self-insures rather than replacing third-party insurance);

6) Deals that are prearranged in such a way that the captive's profits ultimately inure to the benefit of the business, the business owner, or his/her family on a tax-favored basis (e.g., via premium refunds, dividends, loan backs, etc.);

7) Arrangements that mention life insurance and captives in the same sentence;

All of that's fair enough, I suppose. I mean, every man is entitled to his opinion as to what constitutes a red flag, right? But what if that man speaketh out of self-interest and with a forked tongue? Should his opinion on the topic then be trusted?

Keep that question and the seven red flags above (according to Jay) in mind as you peruse the presentation on captives that Jay Adkisson and Tom Vorhees gave a couple of years ago to the Association for Advanced Life Underwriting (a life insurance industry group comprised of America's top life insurance agents). As we shall see, this presentation raises every single supposed red flag, and many more than once. (In reading the analysis of Jay's presentation below, the numbers appearing in parentheticals after certain sentences correspond to the numbered red flags above.)

Let's begin with Slide 12 of the presentation, which you can see for yourself by following the above link. It lists the "Primary Benefits of Captives". Note that it specifically emphasizes income tax planning opportunities (especially the ability to reserve for claims on a pre-tax basis and the tax "arbitrage" available by trading ordinary income taxes for long term capital gains)! The same slide also emphasizes opportunities for estate and gift tax planning via a captive. Again, these are not noted as simply ancillary benefits of owning captive but as "Primary Benefits of a Captive", as the slide's title suggests. Does this not clearly raise supposed red flag number 2 above? Or...is it only a red flag if someone other than Jay raises it?

Slides 18, 19, and 21 continue with describing the income and estate tax planning opportunities of a captive (2), with slide 21 specifically describing how a captive can loan its assets back (6) to its owner (in this case an irrevocable trust for the benefit of the business owner's children).

Slide 24 discusses the ability to do "group captives" (1). You remember those, right? Jay says in his quote above that group captives formed with an eye towards tax savings (which he just emphasized in previous slides) are indicative of a "tax shelter".

Slides 25 goes on to discuss life insurance in particular, noting specifically that it is a "permissible investment" (7). In fairness, would a reader of Jay's Forbes article conclude that investments into life insurance by a captive are permissible? Hardly! The IRS will "act as your proctologist", he warns.

Slide 25 continues by emphasizing the tax advantages of life insurance (2 and 7) as opposed to its many economic advantages (e.g., the guaranteed right to borrow against cash surrender values on a non-recourse basis, etc.). It notes specifically that captives can be structured from the beginning so that they, and therefore the death benefit of the life insurance policies they own, are outside of the business owner's taxable estate, resulting in a "dramatic" planning impact (2, 3, 6 and 7). It further notes that the life insurance owned by the captive (7) can be used to provide key-man coverage and facilitate buy-sell and split-dollar arrangements, all of which directly benefit either the business, the business owner personally, or the business owner's family (6), but not necessarily the captive itself. This slide does caution against arrangements that are designed "just" to sell "pre-tax life insurance", but how is the reader to know when that's the case? Jay's implied answer: It's not the case if Jay Adkisson does your captive work (ha!), but with anyone else it's buyer beware.

Unbelievably, Slide 27 lists again the potential benefits of owning a captive, and notes first and foremost the ability to "create business tax deductions for the insured company" resulting in the ability to have a "tax-advantaged investment portfolio" (2, 3). It also lists as benefits "create family wealth transfer opportunities" and "purchas[ing] life insurance on the owner" (2, 3, 6 and 7).

Slide 30 begins a section titled "Illustrating a Group Captive" (1). Oh no, there's that bad word again--"group captive". Slide 31 compares the benefits of a business participating in a group captive arrangement to doing nothing (i.e., maintaining the status quo). In the "Benefits Comparison" section of the slide, it notes first and foremost that the group captive results in significant "annual deductions from business income", then it calculates the "ten year estimated income tax savings" from the arrangement (nearly $3 million!), and finally it highlights specifically the estate tax planning opportunity afforded by the arrangement (1, 2, 3, 6 and 7).

Slide 32 begins an entire section on "Integrating a Single Parent Captive into a Blueprint for Improving After-Tax Capital for Retirement Income and Wealth Transfer" purposes (2, 3 and 6). Slide 33 notes that "every premium dollar paid [to a properly structured captive] is a tax-free transfer outside the estate" (2, 3 and 6). How could that be unless the business owner had planned in advance to have the captive owned by an irrevocable trust or other appropriate entity or perhaps his children? And, how could he have decided to do that without considering the tax planning opportunities of the structure ab initio? And, why in the world would he have bothered to do that unless tax planning was a significant consideration in the overall structure?

Slides 34 through 36 offer up a specific case study highlighting exactly how captives can be prearranged to create estate and income tax savings opportunities (2, 3 and 6), the benefits of which are summarized on slide 37. It notes specifically that the captive results in "increased income tax deductions" of some $8 million dollars over the period in question, and results in nearly $7 million of federal estate tax savings (2, 3 and 6)!

Slide 39 begins a discussion of the types of risk that might suitably be insured through a captive. The opening sentence on this slide says "a key to a profitable captive is identify and insure risks that are legitimate but have a low probability of happening" (4). Why? So the captive can be more profitable? So it can better pay claims? No! Because "insuring risks that have a high probability of occurring would inhibit the ability of the captive to help achieve the owners (sic) other financial goals" (2, 3, 4, 5, 6 and 7). It notes further that a qualified underwriter should have little trouble identifying suitable risks. And finally, it provides a listing of potential low-risk coverages that one might legitimately insure through a captive. Included in this list is...you'll never believe it..."loss due to terrorist attack" (4) (notably with no exclusion mentioned for residents of fly over states like Tennessee).

The remaining twenty-two pages of the presentation is a series of slides that, in light of Jay's comments quoted above, should leave the reader positively gobsmacked. In the interest of time, I can only highlight a few:

Slides 40 and 41 discuss structures through which the captive can make indirect loans to family members or invest into life insurance on the business owner (6 and 7). Slide 41 is specifically titled "Ways to Invest Capital Fund in [Life] Insurance" (6 and 7). Slide 47 discusses, once again, how the captive's assets can be invested so as to "Improve After Tax Capital for Retirement Income and Wealth Transfers" (6 and 7). Slide 52 highlights the economic and tax benefits of the captive investing into life insurance (6 and 7), which are considerable. Slide 53 notes that life insurance is, first and foremost, "demonstrably more tax efficient" than other investments the captive might choose (6 and 7). It then goes on to provide a number of suggestions for captives that wish to pursue this alternative.

Slide 54 and 55 demonstrate in graphical and numeric form the positive economic impact of using life insurance inside of a captive (6 and 7). Slide 56 qualifies these discussions by noting that they assume that the captive was previously formed for "the purpose of providing insurance", but goes on to note that "it is not unreasonable for the investment decisions made by the CIC to be influenced by long-term exit strategies, so long as investment decisions do no compromise the CIC's ability to provide insurance" (2, 3, 6 and 7). Thus, as noted on slide 58, captives can be "owned at inception by [an] estate planning vehicle, such as a trust" (2, 3, 6 and 7).

And, presumably it's not improper to plan in advance for the ultimate tax-favored disposition of the captives assets. For instance, slide 59 notes two ways of doing so--via operating or liquidating dividend (either of which, it is noted, is currently taxed at capital gains rates) (2, 3, 6, and 7).

Taking all of these slides in context, it is clear that Jay has no issue with intentionally contemplating and maximizing the tax benefits of the captive structure, or investing its assets into life insurance, or arranging in advance for the ultimate tax-favored disposition of the captive's assets to the business owner or his family at some point in the future, just so long as the captive was originally formed "for the purpose of providing insurance". Now, in fairness, would any reader of the Forbes article quoted above come to this same conclusion as to Jay's views on these points? No. So query why in the world Jay strives so hard to create a false impression in the mind of Joe Public?

To conclude, it is impossible to read Jay's public writings and view his private presentations (or even his actual legal work) without concluding conclusively that he's an unethical hypocrite. In this single presentation to the Association for Advanced Life Underwriting (and there are yet other examples), Jay Adkisson advocates doing exactly what he warns the public to avoid lest they be thrown into prison for tax fraud. He not only raises every single one of his own supposed red flags, but he waives each viciously.

Which raises a key question: Was he lying then (when he delivered his presentation to the AALU), or is he lying now? Are these really as big of red flags as Jay would have the public now believe? For instance, should the public really "run" anytime anyone mentions life insurance in conjunction with a captive or emphasizes it's tax benefits? If so then, they now know to include Jay Adkisson, the world's best-known captive promoter, among those from whom they should flee.

My issue with Jay is simply this: This man, who works in a tiny firm, whose father answered the phone for him last time I called his office, and who doesn't even have published Martindale peer review ranking, would have the public believe that only he is sufficiently knowledgable and skilled to guide it through what he insists is very dangerous territory. Hire any other as your guide, Joe Public, and you very well might be "eating with a spork [in prison] on Christmas morning"! In Jay's world, other captive professionals, no matter what their credentials or experience, and no matter how superior their Martindale rating, are embezzling con men or tax frauds at worst and naive incompetents at best. What a crock! It's time for other professionals to speak out on against this crap.

As for the public at large, let me ask the reader a simple question: Would you buy a used car from a man who was constantly implying to you that, if you purchase a vehicle from anyone else, it very well may be a lemon (at best) or a death trap (at worst)?

Of course not. Remember that the next time you read an article by Jay Adkisson.


UPDATE:> Jay might try to dodge the criticisms noted above by pointing to Slide 5. Slide 5 says that everything that comes after it assumes that the client has a non-tax reason for the insurance to be offered by the captive and that the presentation is only meant to explain "ancillary benefits" of a captive. Review the presentation and decide for yourself whether this is true. In light of what the other slides actually say, color me skeptical.

But, even if it is true, it does not help Jay dodge his own bullets. For instance, he says explicitly to run from anyone who mentions life insurance in the same sentence as a captive or who emphasizes the tax-planning opportunities they provide. He does not qualify this statement in the Forbes article by saying "well...unless life insurance and tax planning is just an ancillary benefit." And yet the presentation he gave to a group of the life insurance industry's top salespersons spends an inordinate amount of time describing in excruciating detail the tax planning benefits of a captive and how life insurance can improve those planning opportunities.

And, he says that businesses shouldn't purchase low risk policies (like terrorism insurance in Tennessee) from their captive, and then he participates in giving a presentation that says the exact opposite. He doesn't say in his Forbes article that low risk policies are okay so long as they are merely an "ancillary benefit", does he? No! Instead he insists that says that low-risk policies are indicia of "tax shelters." Who is he trying to fool? You? Me? Joe Public? The IRS?

And lastly, doesn't Jay think that every other captive "promoter" (be it a CPA, attorney, captive manager, or life insurance salesperson) in the country has a page in his/her presentation that says exactly the same thing (more or less) as his Slide 5? Of course they do. And they do so because, contrary to his constant implication, they have no more interest in helping people set up inappropriate captives than Jay does. Or...er...in light of Jay's presentation, maybe I should rephrase that.

Anyway, the point is that Slide 5 is utterly useless to the public in helping it distinguish between the good guys and the bad guys about which Jay is so fond of warning them. If it's acceptable for Jay Adkisson to talk extensively about the "ancillary benefits" of owning a captive with only a disclaimer page here or there, as he does in the AALU presentation, then it's just as acceptable for other professionals, even life insurance professionals or captive managers, to do that same. And doing so doesn't make them promoters, tax cheats, shills, embezzlers, greedy bastards, or any of the other tawdry labels that Jay is so fond of throwing around. Jay should be absolutely embarrassed and ashamed for suggesting otherwise.


UPDATE 2:> Jay had this to say today in response to one of the comments on his LinkedIn captive blog discussing his Forbes article [the bracketed comments below are my own]:

Barry: "Is it not true the iRS has deemed 50% appropriate use of reserves for life insurance?"

Not that I am aware of -- what are you basing this on?

[The IRS has not issued any guidance on what constitutes an appropriate or inappropriate level of life insurance in the context of a captive.]

Not all life insurance inside a captive is per se bad -- in some limited circumstances it may make economic sense to have life insurance inside a captive. It is simply a "red flag".

[I wonder if readers of his Forbes post would conclude that life insurance is not per se bad, or that in some cases it makes economic sense?]

The concern is where a captive is primarily sold for some purpose other than as a risk management tool for the business, i.e., it is sold as a tax shelter or as a way for the business owner to purchase life insurance with pre-tax dollars, etc.

[I'm not sure why how a captive is "sold" is particularly relevant. What's relevant is why the client in question implemented the captive. Even if a captive was "sold as a tax shelter", which I doubt happens nearly as often as Jay wants the public to believe, does that mean the client implemented the captive for this reason? The last car I bought was "sold" to me as one of the safest cars in the world. I could've cared less. All I wanted was a great ride.]

This is what some of the audits in Atlanta are all about -- the IRS obtained some literature from promoters where captives were marketed as tax shelters and had life insurance illustrations built into the proposals. [Like you did in your AALU presentation, Jay?] The IRS then started audits of some of those who had set up captives through these promoters and found that the premiums paid for the property-casualty insurance underwritten by the captive was significantly overpriced and bore no actuarial relationship to reality, i.e., the premiums were not based on actuarial tables, industry loss history, etc., but rather on "how much of a deduction do you need this year?" [And how exactly, Jay, would you know whether this was true or not? Just because the IRS told you so? If so, what are you doing talking to the IRS about active audits? Did you actually review the pricing of the policies in question yourself? Do you know whether independent actuaries or insurance consultants were involved? Have you never known the IRS to assert a position that was contrary to fact? Could the IRS be wrong in its conclusion? It seems you assume too much. We have a saying here in fly over country about those who assume.]

In my conversations with IRS agents who deal with captives, they have indicated that life insurance is a "red flag" to them, not because life insurance is inherently bad but because it tends to indicate to them that the captive was created for some other purpose (tax savings or wealth transfer) than to underwrite non-life risks. [Again, do you think that's what readers of your Forbes post understood you to say, Jay? And regardless, isn't that exactly what you taught life insurance agents to do in your AALU presentation--that is, to emphasize the "ancillary benefits" of owning a captive like tax savings, retirement income and wealth transfer?]

I don't think that life insurance inside a captive will ipso facto invalidate the captive, but it is something that can draw unnecessary attention to the captive, as well as concerns about the liquidity of the captive and ability to pay claims. It is "another factor" towards the IRS taking the position that the captive is something other than a risk management tool, which a captive is supposed to be, as opposed to a tax management tool, i.e., a tax shelter, which it is absolutely not. So why do it?

[Oh...I don't know. Maybe for all the reasons that you so emphasized in your presentation to the AALU? As was said in the presentation, the economic benefit of including life insurance is..."dramatic" and life insurance is "demonstrably more tax efficient" than other alternatives (your words)].

My advice is to get a second opinion. I'm not saying "go to me" because I don't practice tax law, but go to Chaz Lavelle in Louisville or Tom Jones in Chicago or Bruce Wright in New York or David Slenn in Naples, etc., and get one of those captive tax advisors to give you a second opinion.

[Wow! Now I'm blown away! Jay Adkisson doesn't practice tax law?! I wonder if readers of Jay's posts know that? Perhaps you might mention that at the beginning of each of your rants from now on, Jay. You regularly offer up to the public tax opinions on what constitutes a "tax shelter", or a "tax scam", or a "bogus risk distribution pool", etc., and yet you self-admitedly aren't even a tax attorney?! To make matters worse, Jay, you constantly warn the public not to trust the opinions of others who...you know...actually are tax attorneys--"shills", I think you call them--many of whom who are no doubt far more experienced than you in tax matters and in dealing with the IRS, many of whom no doubt have Master's degrees in Law with concentrations in taxation from prestigious schools like New York University or others, many of whom have practiced in established firms of note, and many of whom have five-star Martindale peer review ratings. How convenient for you!

And, here's a question for Forbes: What the H-E-Double-Toothpicks are you doing publishing the tax opinions of someone who admittedly doesn't even practice tax law? If you're going to have someone scare the public about tax scams, at least find someone that...you know...actually practices in the subject area].

And run -- fast! -- from anybody who advises you not to get a second opinion. [Ahh...at last we agree, Jay. Well, just so long as that second opinion isn't from you. After all, you "don't practice tax law." Please be sure to mention that anytime you offer up tax opinions from now on.]




DISCLOSURE: IRS regulations require me to inform you that this post is not intended or written by 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.

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