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We formed and operate the first series LLC in Montana (named Aegis) for captive insurers. Several other firms provide key services such as accounting, audit and actuarial work. Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company. The facts for this article are from the following case: Michigan Millers Mutual Insurance Company v, DG&G Co. 569 F.3d 808, (8th Cir. 2009) DG&G was a Missouri company that ginned cotton which they delivered to Federal Compass. In December 2005, Federal noticed that DG&G’s product contained significantly more moisture than industry standards, leading several DG&G’s customers to demand payments for damages. The company directly paid $5.1 million after their insurer, Michigan Miller’s Mutual Insurance Company, denied the claim. The situation eventually devolved into litigation involving numerous parties. DG&G had three insurance policies that they thought would pay for their attorneys and damages. They were wrong. Their commercial general liability policy excluded damages caused to property under the company’s care or control; the umbrella policy adopted all the CGLs provisions, so it provided no coverage. And the Agribusiness Policy contained an exemption for “defects, errors, and omissions” in the insured’s machinery. Unfortunately, the company argued mechanical problems caused the moisture problem as part of their case, preventing coverage under this policy. Despite having several insurance policies, DG&G had no coverage. There are several ways a captive would have helped:
Please call us at 832.330.4101 if you'd like to learn more about how a captive insurance company would benefit your business.
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We formed and operate the first series LLC in Montana (named Aegis) for captive insurers. Several other firms provide key services such as accounting, audit and actuarial work. Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company.
In 1971, a jury awarded $21.7 million to the plaintiff in their produce liability case against Beech Aircraft. The company blamed their loss on the insurance company appointed attorneys, who Beech tried to have removed several weeks before trial. The loss was the catalyst of Beech’s decision to form a captive insurance company which allowed them to draft the insurance policy, thereby controlling the attorney selection process in the event of future litigation. Of all the earliest captive cases, Beech best demonstrates the benefit of forming a captive to gain control of the policy drafting process. Facts that highlight the importance of controlling the drafting process are not limited to the early captive cases. The 2016 decision of Atlantic Casualty Insurance Co. v. Gustafson et. al is illustrative. The case’s facts are very simple. The defendant owns and operates Gustafson Excavating and Septic Systems. A homeowner was struck in the eye by debris while watching one of Gustafson’s crews removing brush. The company contacted their insurance agent who stated their policy provided coverage for the injury. The insurance company disagreed, citing the following policy language: This insurance does not apply to: * * * (ii) “bodily injury” to any “contractor” for which any insured may become liable in any capacity: * * * As used in this endorsement, “contractor” shall include but is not limited to any independent contractor or subcontractor of any insured, any general contractor, any developer, any property owner, any independent contractor or subcontractor of any general contractor, any independent contractor or subcontractor of any general developer, any independent contractor or subcontractor of any property owner and any and all persons providing services or materials of any kind for these persons or entities mentioned herein. The insurer argued that the homeowner was a “property owner” within the contract’s definition, meaning the exclusion applied, allowing the insurer to deny coverage. The insurer made the same argument in a 2013 case tried to Judge Posner who observed, “The exclusion is poorly drafted.” But that is exactly the point. While contract law governs the formation and interpretation of insurance policies, there are important differences between contracts negotiated between two parties of equal standing and those issued by an insurance company and then sent to the insured. In the former, parties negotiate all the terms and conditions; in the latter, the insurer either drafts the policy or uses an industry standard document issued by a service such as ISO. In either case, the insured has no input into the contract’s language. And the complete lack of drafting control gives the insurer numerous opportunities to write exceptions, exclusions and fine print that are not to the insured’s advantage. This is exactly what happened in this case. The policy language was so broad that it included, literally, everybody imaginable. The first court noted, “If viewed on its own, that term would include virtually everyone in the world; even the poorest person at least owns the clothes on his back, thus making him a “property owner” and, therefore, presumably a “contractor” under a broad reading of the statute.” Had the insured had a captive, he would have drafted the policy, preventing this problem from occurring in the first place. If you think a captive would be an appropriate option for your business, please call us at 832.330.4101 to discuss this option in more detail. Thanks to the Contract Professor website for discussing this case. On Wednesday, June 15th, we're hosting a webinar titled "An Introduction to Captive Insurance." It starts at 1PM CST and will last for about half an hour. You can sign up at this link.
We formed and operate the first series LLC in Montana (named Aegis) for captive insurers. Several other firms provide key services such as accounting, audit and actuarial work. Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company. The following is an excerpt from our book U.S. Captive Insurance Law: After mentioning the general facts, the appellate court first noted, “It is not perfectly clear on what judicial doctrine the holding rests.” Next, the court noted that this was essentially a sham transaction case, with the IRS arguing that the court should not respect the transaction, because its only motive was tax avoidance. The court first outlined the basic concept of the sham transaction doctrine: This economic-substance doctrine, also called the sham-transaction doctrine, provides that a transaction ceases to merit tax respect when it has no “economic effects other than the creation of tax benefits.” Even if the transaction has economic effects, it must be disregarded if it has no business purpose and its motive is tax avoidance. In other words, the plaintiff must prove that there is a legitimate, non-tax business purpose to the transaction in order to avoid the application of the sham-transaction doctrine. The appellate court noted that “economic effects” include the creation of genuine obligations enforceable by an unrelated party. The court noted that a legitimate insurance contract existed between OPL and NUL, which NUL had the right to enforce. The tax court “dismissed these obligations” because of the reinsurance agreement between NUL and OPL, arguing that NUL was nothing more than a conduit for payment from UPS to OPL. In addition, UPS actually lost the income, given OPLs separate taxable status. Finally, the court noted that the tax court was stretching the business purpose doctrine farther than it was intended to go. The court sided with UPS and remanded the case back to the trial level. End excerpt I previously noted that the UPS appellate decision is incredibly weak. The above excerpt explains why. The appellate court completely ignored the assignment of income doctrine, which was fully developed and painstakingly documented by the lower court. Instead, we see the incredibly weak, "a valid contract was created" argument, followed by the statement this is adequate grounds to uphold the transaction and satisfy the economic substance doctrine. To put it bluntly, the appellate court has absolutely no idea or concept regarding the economic substance doctrine, which is a two prong test that has both an objective and subjective component. In addition, many transactions voided by previous courts because they lacked economic substance contained valid contracts. Either the court knew this and chose to ignore it, or they didn't know it and marched forward. Either way, their decision is at best laughable. However. it is also apparent from the lack of true legal justification for their decision, that the appellate court was sending a message: we will not void a captive insurance transaction, period. As this was the last case brought by by the IRS, it's obvious they got the message. On Wednesday, June 15th, we're hosting a webinar titled "An Introduction to Captive Insurance." It starts at 1PM CST and will last for about half an hour. You can sign up at this link.
We formed and operate the first series LLC in Montana (named Aegis) for captive insurers. Several other firms provide key services such as accounting, audit and actuarial work. Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company. The facts used in this post are derived from the following case: Delta and Pine Land Company v. Nationwide Agribusiness Insurance Company, 530 F.3d 398 (5th Cir. 2008). The Delta Pine and Land Company sold seeds to farmers. They purchased a commercial general liability and umbrella policy from Nationwide Agribusiness. Each policy had a rider that specifically extended coverage to products sold by the insured. In 2002, 56 customers sued Delta, alleging the company’s seed resulted in substantially lower crop yield. Delta filed a declaratory judgement against Nationwide for indemnification and legal fees. Nationwide responded with a request for declaratory judgment and won. Delta appealed. These facts are unremarkable. A company that sells a specific product purchased insurance to provide coverage for product defect. After being served with notice of a lawsuit, they petitioned the court to determine the legal rights under their policies. Any company that has purchased insurance and then been sued for a claim can relate to these facts. Why didn’t the insurance company simply grant the insured coverage? While we are not privy to the insurance company’s thinking, it’s possible they determined the costs of litigation against the insured were far lower than a potential payout to 56 litigants. The lower court proved them right. How would a captive benefit Delta Pines in this fact pattern? The company petitioned the lower court to rule that the insurer should provide legal representation for the insured. When Delta lost, they had to find an alternate source of payment, which was most likely free cash flow. But most captives provide a legal liability coverage that provides funds to pay for representation in the event of a lawsuit, mediation or arbitration. This would have prevented the drain on their finances caused by the litigation. Issues related to the seed liability are a bit more complicated. The standard CGL policy excludes risks related to a product sold by the insured. Most umbrella policies have the same terms and conditions as their CGL counterparts to insure continuity of coverage. But here, both policies had a rider that specifically included the insured’s product. It’s well within reason to assume the insured added these riders because they believed they covered product liability. Then why did the trial court rule against the insured? This is purely speculative, but contract interpretation is not an exact science. It’s very possible the lower court ruled against the insured due to the inherent tension between the “your product” exclusion and riders that were supposed to include seed based products. A captive would have given the insured two options for product liability coverage. They could have purchased a CGL policy with a large deductible. Then, their captive could sell the parent a deductible reimbursement policy to cover the gap. Or, they could have simply written a product liability policy to cover the first layer of risk and then purchased an excess policy to provide top layer coverage. Either option is viable. And both would have eliminated the initial cost of having to trial and appellate litigation. Delta found out the hard way contract interpretation isn’t always friendly to insureds. And the larger the claim filed, the higher the possibility that the insurance company will try and find a way to limit their payout. This is why a captive that covers at least some of your risk makes a great deal of sense. Please call as at 832.330.4101 if you’d like to learn more. On Wednesday, June 15th, we're hosting a webinar titled "An Introduction to Captive Insurance." It starts at 1PM CST and will last for about half an hour. You can sign up at this link.
We formed and operate the first series LLC in Montana (named Aegis) for captive insurers. Several other firms provide key services such as accounting, audit and actuarial work. Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company. In analyzing UPS’ situation before and after it established the captive, the tax court noted that UPS performed all the work related to the EVCs before and after the transaction: Before January 1, 1984, petitioner performed all the functions and activities related to the EVC's and was liable for the damage or loss of packages up to their declared value. After January 1, 1984, petitioner continued to perform all the functions and activities related to EVC's, including billing for and receiving EVC's, and remained liable to shippers whose shipments were damaged or lost while in petitioner's possession. Petitioner continued to receive shippers' claims for lost or damaged goods, investigate and adjust such claims, and pay such claims out of the EVC revenue that it had collected from shippers. The difference between petitioner's EVC activity before and after January 1, 1984 was that after that date it remitted the excess of EVC revenues over claims paid, i.e. gross profit, to NUF, which, after subtracting relatively small fronting fees and expenses, paid the remainder to OPL, which was essentially owned by petitioner's shareholders. The only difference between UPS’ pre- and post-1984 arrangement was the insertion of NUF and OPL into the equation. However, if that arrangement did not have economic substance, the court would not recognize the arrangement. Hence, at trial this case’s focus was the objective and subjective substance of the transactions between UPS and NUF and NUF and OPL. UPS first stated it created the transaction between UPS, NUF and OPL out of concern that the EVCs were insurance for which UPS did not have the requisite state licenses. As a result, UPS’ business purpose for the transaction was to bring an existing business practice in line with various state laws. However, for this claim to be valid, UPS would have to demonstrate that it “was motivated by a good faith concern that it was illegal for petitioner to continue to receive the excess value income.” But UPS never obtained a legal opinion regarding the possible legal status of the ECV program. In addition, after the program was in place, UPS continued to sell ECV policies to shippers in the same manner as before the transaction was established. Finally, at trial, UPS did not offer any documentary evidence to back up this assertion. Other of petitioner’s arguments were proven inaccurate by documentary evidence or testimony at trial. First, UPS argued that its business purpose for establishing OPL was to create a viable insurance company as a profit center for the company overall. However, the court noted that there were plenty of ways UPS could capitalize this new venture without diverting excess value premiums to OPL. UPS also argued its business purpose was to allow the company to raise insurance rates. But this assertion was proven incorrect by testimony from petitioner’s own witness at trial. UPS also argued the new arrangement was a form of asset protection – that it lowered UPS’ exposure to risk and therefore protected the company’s core assets. However, UPS continued to be primarily liable on many aspects of the ECV after the implementation of the captive insurance company. Therefore, the company was still essentially liable, and its claim was proven incorrect by the facts. The court next determined whether the rate charged by UPS for its ECV policy was an arm’s length price. The service procured an expert named Mr. Kelly to demonstrate that the rates charged for EVCs were higher than would be charged in a competitive market. To demonstrate this fact, Mr. Kelly noted that OPL had a loss ratio of 33% – meaning the company paid out approximately 33% of premiums received in the form of payment for claims. Mr. Kelly testified that this rate of profit retention would have driven clients away. The court also noted that another UPS subsidiary named PIP charged a lower rate (0.125 cents per $100 – about half the ECV rate) for its insurance. Several other experts backed-up this claim. Even an expert procured by the petitioner conceded that UPS’ ECV rates were high. As such, the court determined that the rates charged were not at arm’s length, making the transaction a sham for tax purposes. Finally, the court noted that the petitioner’s sole purpose for entering in the transaction was lowering its federal tax burden. The petitioner’s insurance broker prepared an original report stating that UPS could save $16 million in federal taxes the first year the plan was put in effect. Other documents procured at trial demonstrated that tax reasons were the petitioner’s primary motivation for entering into the transaction. For all of the reasons listed, the court ruled that the payments UPS deducted as insurance premiums were not legitimate business deductions. UPS appealed the decision. |
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