Like last time, Jay's comments are full of self-serving and misleading statements, exaggeration and scare tactics. And, once again, I shall count the ways that his comments fall short of the truth:
First, Jay suggests that "terrorism insurance in Tennessee" is an illegitimate risk to insure through a captive insurance company (or perhaps he means through any insurance company?). Sounds about right for a "city slicker" who considers everything between LA and New York to be fly-over country. As a stereotypical city slicker, Jay can't be expected to know that virtually all the uranium for the United States' first atomic bombs was enriched in Oak Ridge, Tennessee as part of the Manhattan Project, or that a significant portion of the nation's bomb-grade uranium is stored there today, or that Oak Ridge National Laboratory, a top secret facility, still conducts much of the country's nuclear and scientific research? All of these things, and more, make Oak Ridge both a perfect strategic and symbolic target for terrorists (much more so than say...oh...the Murrah Federal Building in Oklahoma City), but Jay can't be expected to know that.
And, he can't be expected to know that two of the nation's nuclear power plants operate in Tennessee, or that the Tennessee Valley gets a large percentage of its power from dams. Both nuclear power plants and dams make ideal strategic targets for terrorist attack, no? How many businesses in Tennessee could operate without power?
Maybe Jay's problem isn't with Tennessee in particular, but with terrorism insurance in general. Maybe he doesn't consider terrorist attack to be a "real" risk to most small businesses? Well, if that's the case, he should know that his government disagrees with him. The Department of Homeland Security has a website that emphasizes the risk of terrorist attack to small businesses and implores them to prepare. This website includes a link to the Emergency Preparedness and Business Continuity Standard that, among other things, emphasizes the importance of insurance in mitigating risk, including terrorism risk. For instance, it says specifically that "the mitigation strategy should include...acceptance/retention/transfer of risks (insurance programs)." FEMA likewise has a page that emphasizes the risk of terrorist attack and recommends preparedness planning. Interestingly, neither of these government pages say that the recommended precautions don't apply to Tennesseans.
Additionally, when it passed the Terrorism Risk Insurance Act (TRIA), which specifically mentions captive insurance companies, Congress itself recognized that terrorism is a real threat to the American economy, and that an inability to obtain reasonably-priced terrorism insurance jeopardized America's economic security. TRIA says:
The Congress finds that—
(1) the ability of businesses and individuals to obtain pro-
perty and casualty insurance at reasonable and predictable prices, in order to spread the risk of both routine and cata- strophic loss, is critical to economic growth, urban development, and the construction and maintenance of public and private housing, as well as to the promotion of United States exports and foreign trade in an increasingly interconnected world;
(3) the ability of the insurance industry to cover the unprecedented financial risks presented by potential acts of terrorism in the United States can be a major factor in the recovery from terrorist attacks, while maintaining the stability of the economy;
(4) widespread financial market uncertainties have arisen following the terrorist attacks of September 11, 2001, including the absence of information from which financial institutions can make statistically valid estimates of the probability and cost of future terrorist events, and therefore the size, funding, and allocation of the risk of loss caused by such acts of ter- rorism;
(5) a decision by property and casualty insurers to deal with such uncertainties, either by terminating property and casualty coverage for losses arising from terrorist events, or by radically escalating premium coverage to compensate for risks of loss that are not readily predictable, could seriously hamper ongoing and planned construction, property acquisition, and other business projects, generate a dramatic increase in rents, and otherwise suppress economic activity....
In light of the government's own proclamations on the risk of terrorism in general and the importance of terrorism insurance to small business and the American economy as a whole, Jay's contention that such coverage is irrelevant to most small businesses (especially those in Tennessee, I guess), or that most small business owners must be acting under pretext when considering the effect of a terrorist attack on their business, is either ignorant or disingenuous. At this point, I suspect the latter.
Or, maybe it's not that Jay has issues with terrorism insurance in general, but with how such policies are priced in the captive market. For instance, he says: "Would you normally buy [terrorism] 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."
Really? Surely Jay does not mean to suggest that the only risks one can legitimately insure via a captive are those that the business previously insured through a third party. After all, the very reason captives were "invented" to begin with was to insure against risks for which coverage could not be obtained at a reasonable price in the third party insurance market. If coverage for an undeniably real risk were available from third parties at a price the business owner considered reasonable, then wouldn't every business owner just purchase the insurance from a third party rather than bother setting up a captive? The only reason to form a captive is if the business owner considers the premium charged by third party insurers to be unreasonable in light of his assessment of a given risk. By setting up a captive, every business hopes to retain the likely (but not certain) underwriting profits for itself, profits that would otherwise inure to the benefit of a third party insurer.
And, Jay must surely know that terrorism insurance policies offered by third party insurers often exclude the most important risks--i.e., losses from chemical, biological, nuclear, and/or radiological attack. Likewise, he must know that third-party policies typically only provide coverage for damages to property and not loss of business income (unless, in some cases, the loss of income is directly attributable to property damage). And yet, for most small businesses, the latter is much more important than the former. Direct damage from a terrorist attack may be unlikely for any single small business, but indirect damage to a small business resulting from loss of income is an all-too-real, and potentially devastating, possibility.
And yet protection against the above-described risks is often not available from third party insurers at any reasonable price. Were it not for the federal government subsidizing the cost of terrorism insurance via TRIA, it might not be available at all. Consider whether this is because the risk of loss to the insurance industry by providing such coverage is too small (i.e., because the risk is bogus, as Jay implies) or whether it is because it is too great! Clearly, it's the latter. Thus, these risks are very, very real, even in fly-over states like Tennessee. If they weren't, every insurance company in the world would be offering protection against nuclear, chemical and biological attack to Tennesseans for almost nothing, and TRIA would be unnecessary. And yet they don't, and it isn't. Quite the contrary. This itself is sufficient to refute Jay's silly assertion that premiums charged by captives for terrorism insurance are generally bogus and inflated.
Terrorism insurance is commonly purchased through captives not because it is a bogus tax-dodge, as Jay suggests, but because it is an economically feasible way to managing a very real risk and because policies offered by captive insurance companies typically insure one or more of the excluded risks noted above (e.g., many cover chemical and biological attack) at a cost that's reasonable to a business owner once he considers that he retains a share of the captive's profits. Also, unlike many third party policies, captive policies often cover not just direct losses that may result from a terrorist attack, but indirect losses as well. Given that equivalent policies are not available from third party insurers for any reasonable premium, most any premium charged by a captive for such coverage can't be de facto unreasonable. If anything the amount that most captives charge for such terrorism insurance can be criticized for being too low!
But, to prove another point, let's engage in a thought experiment: Let's assume for a minute that a business owner could buy purely third party insurance that would cover terrorism risk to the same extent as captive policies at some reasonable, albeit very high, cost. Does the fact that a given business owner may choose not to suffer a certain very high loss (by way of third party insurance premiums) in order to protect against an uncertain extraordinarily high loss (i.e., terrorist attack) mean that it is de facto unreasonable or disingenuous for the business owner to try to mitigate the impact of terrorism risk through captive insurance where he/she retains any underwriting profits? In other words, should such a business owner be barred from a captive arrangement simply because he would never purchase identical insurance from a third party at the same extraordinarily high price? Of course not. Yet, this is what Jay would apparently have his readers believe.
Next Jay goes on his traditional diatribe against life insurance. First he suggests that a captive investing in life insurance is somehow improper (i.e., the IRS will "act as your proctologist"). In response I will ask one simple question: Can Jay cite even a single federal statute, regulation, revenue ruling, court case or private letter ruling that holds that it is in any way improper for a C-corporation in general, or a captive insurance company in particular, to invest into life insurance? I'll save you the wait and state unequivocally that he can't because no such authority exists. Are we to fear IRS examination so much that we pass on doing perfectly legal things in hopes of avoiding an audit? Only people who have something else to hide should be inclined to take this approach.
The fact is that C-corporations invest into life insurance all the time. To provide just one (among innumerable) examples, a study by the American Society of Actuaries done some years ago indicates that nearly seventy percent of Fortune 1000 companies invest their non-qualified deferred compensation plan money, the money that is expected to fund retirement for the company's most senior executives, in...you guessed it...life insurance. There are many reasons why almost seventy percent of the country's most sophisticated CFOs made that decision, and at least some of those reasons apply in the context of a captive insurance company. There is absolutely no reason whatsoever that an honest taxpayer who chooses to have his captive invest in life insurance for legitimate economic reasons should fear the IRS, at least not any more than an honest CFO who funds his retirement plan with life insurance should. Jay should be ashamed for implying otherwise.
Jay next slanders life insurance arrangements as paying "obscene" commissions to those pesky "promoters", presumably making them a raw deal for the consumer. Really Jay? Those Fortune 1000 executives who invest their own retirement dollars in life insurance must be pretty stupid people, getting "hoodwinked" by those slick life insurance salespeople all the time. Apparently, Jay, you're not just an expert on captives, but you know more about life insurance than most Fortune 1000 CFOs as well! Your expertise knows no bounds.
Jay's criticism of life insurance combined with captives is all the more mystifying since he gave a talk a few years ago to the Association for Advanced Life Underwriting (a group made up of the industry's top life insurance salespersons) describing in detail (in addition to all the various tax planning opportunities captives provide) how captives can be combined with life insurance to achieve important planning objectives. Talk about a shill! If Jay's admonition to run from anyone who even mentions life insurance in conjunction with captives is to be taken literally, then include Jay Adkisson among those from whom the reader should run. The fact is that Jay himself has on more than one occasion formed captives where life insurance was involved.
Lastly, Jay continues with his all-too-familiar scare tactics designed to drive business away from others and toward his firm. He implies over and over throughout the "article" that anyone who does business with a captive professional (other than himself, it is implied) is taking their lives into their own hands. For instance:
Reading the article at the above link, you might be forgiven for thinking that everybody who mentions a captive, other than Jay, is a "promoter." How silly: There's simply no captive attorney in the country who has been more involved in self-promotion in general and promotion of captives in particular than Jay Adkisson. Adkisson is a captive promoter extraordinaire! A simple Google search will prove the point. Anyone who fears high profile "promoters" should fear Jay first and foremost.
Jay also suggests that if tax savings is a consideration in establishing a captive, then there's "no true economic purpose" for the entity. Really Jay? Can you find me a single court case that says that tax planning can't play any role in a contemplated transaction lest its economic substance be jeopardized? I wonder if Jay contributes to a 401(k) or an IRA and, if he does, whether he takes a deduction? Why would anyone would ever contribute to a 401(k) (that had no match) if he didn't get a tax deduction by doing so! Why would anyone voluntarily tie up his or her own money in a plan controlled by his/her employer--where he/she can't get to the money unless he/she first dies, becomes disabled, or terminates service; where he/she has a limited number of investment options chosen by someone else; where there are penalties if he/she takes the money out and spends it prior to 59.5, and additional penalties if he/she leaves it in past 70.5--if they didn't get a tax deduction in return? They wouldn't. The simple fact is that the only reason most people fund their 401(k)'s and IRAs is because they get a deduction. Does this mean that IRAs and 401(k)'s have "no economic substance" and are just "tax shelters"? Again, of course not. Admittedly tax planning probably should not be the primary motivation in forming a captive, but to imply that tax considerations must be ignored or down-played is just dishonest. Jay knows better.
He also suggests that there's something improper about the fact that the amount of captive premiums (in many cases) just so happens to equal the amount of the business owner's desired tax deduction for the year, as if that's improper. First, I'm not so sure that this is true since, in my experience, people desire much greater tax deductions than they typically obtain via captive premiums. Thus, captive premiums are typically less than the desired deduction, not equal to it. However, Jay is correct that, in the captive world, the amount of budgeted premium typically drives the amount of coverage purchased (rather than the desired amount of coverage driving the amount of premium), but that's every bit as much a function of general business budgeting considerations as tax planning. But, even if the amount of premium is driven in part by tax planning considerations, does that make the arrangement somehow de facto improper or a sham? Of course not. After all, isn't the amount of every single 401(k) or IRA contribution usually driven by a combination of budget considerations and the desired amount of a tax deduction (or the government's contribution limits)? Of course. Very, very few of us have actually taken the time to do the math that is necessary to make sure that we don't contribute any more or less to our 401(k) or IRA in a given year than is necessary to actually fund our retirement. Does this mean that our retirement plan contributions are shams? Of course not. Likewise, so long as a business isn't purchasing from its captive more insurance than it reasonably needs, the fact that budgeted premiums drive the amount of insurance purchased rather than the amount of insurance driving the premium is in no way improper.
Jay then warns about arrangements where premiums paid have no bearing to the "true cost", or where there is insufficient risk shifting and risk distribution, and he (as usual) cautions against relying on actuaries, attorneys or other professionals to determine what a reasonable premium should be or whether risk distribution/shifting is sufficient. Respectfully, Jay, how is Joe Public to know whether premiums and risk distribution/shifting are reasonable without reliance upon professionals? Oh yah, I almost forgot: Your problem isn't with all professionals, just any professional other than you. Everyone else is incompetent, a crook, or a shill in your world. Only you can be counted on to give clients the unvarnished truth and protect them from those mean old folks at the IRS. If I remember that, then at least your writings make a modicum sense.
Next, Jay warns against working with anyone who doesn't have a private letter ruling from the IRS, implying that lack of such a ruling makes an arrangement "bogus". How dishonest! Jay certainly knows that the IRS issues letter rulings only in limited circumstances, and that it regularly declines to do so in areas that are too "fact and circumstances" specific or where it doesn't want to concede any ground or where it simply hasn't arrived at a formal position yet. He likewise knows that there are thousands of perfectly legitimate transactions done every single day that aren't backed by letter rulings. To suggest that absence of a ruling means a transaction is "bogus" or even inherently suspect is just...lying. For what it's worth, it's a virtual certainty that Jay has not himself obtained a PLR for every captive with which he has been involved. Given the time and cost it takes to get one, I'm guessing that he obtained a ruling in only a small fraction of the captives he has formed.
I guess Private Letter Rulings are for the little guys. Great Men like Jay Adkisson can only rarely be bothered, but all of us advisors out here in fly-over country...well...we should be expected to produce one for every client/transaction.
Come on, Jay. Get real.
Remember when you were a kid and you'd let out a "silent but deadly" fart with your friends? What did you do next? If you were like most, you'd immediately shout out "Gross, who farted?!", in a rather shameless attempt to divert attention away from yourself and toward others. However, did you really fool your friends very often? Probably not. They likely outed you after a while. So, here in the fly-over country, we've developed a saying that's relevant to this topic: Whenever someone shout's "Who farted?", especially if they do it loudly and obnoxiously, we are apt to respond "the smeller's the feller!", meaning he who complains about the fart first and most loudly probably did it.
And when it comes to captive insurance companies, no one's out there screaming "Who farted?!" more loudly and obnoxiously than Jay Adkisson. As Shakespeare said, "the [man] doth protest too much." Remember that the next time you read an article by Jay.
UPDATE:> Shockingly, the Tennessee Highway Patrol doesn't know that terrorism isn't a threat in Tennessee. If only they'd listened to Jay, they wouldn't have wasted their money.
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.