The IRS’ proposals for identifying certain 831(b)-electing captives as ‘listed transactions’ have rocked the micro-captive space this year. In this Q&A with David Findlay, CEO of Lakeland Financial and Lake City Bank, we hear from a microcaptive owner who will be directly impacted by these new rules – he explains the value the captive has given to the group and the damage the new proposals would cause if they go ahead unchanged
Captive Review: Hi David please introduce yourself and your role and responsibilities at Lake City Bank?
David Findlay (DF): My name is David Findlay and I serve as the chief executive officer of Lakeland Financial and Lake City Bank. I also served as president and chief financial officer from 2010-2014 and chief financial officer from 2000-2010.
CR: Can you tell us about your captive?
DF: Our captive is titled the LCB Risk Management, Inc. and it does qualify as a micron-captive. Our assets were $7.5 million as of December 31, 2022. The entity is a subsidiary of the Lakeland Financial Corporation holding company and was organised in Nevada in 2012.
The captive was created in response to double and triple-digit increases in commercial insurance premiums, limitations on capacity and additional sub-limits as well as increasing deductibles. As a result, the company engaged a national accounting firm to complete a feasibility study analysing the bank’s insured and uninsured risks. The detailed feasibility study benchmarked the current insurance programme against peer-sized community banks across the country.
As a result of the feasibility study, management decided to form LCB Risk Management, Inc., a captive insurance company to help manage and mitigate the rising costs of its commercial insurance programme and the bank’s increasing exposure to unfunded risks, many of which are catastrophic. Key to forming its captive, the company engaged an accredited actuarial firm to review all coverages to be insured by the captive. Annually, the actuary calculated the premium for the various insurance policies issued by LCB Risk Management, Inc. for the benefit of the company based on commercial insurance rate tables, the company’s historical claim experience, industry claim experience, and exposures.
LCB Risk Management Inc., is regulated by the State of Nevada Division of Insurance and is required to provide its pricing analysis to validate the premiums paid to LCB Risk Management, Inc. at inception and with any subsequent changes to the captive coverage.
Upon establishment of LCB Risk Management, Inc., the company entered a reinsurance arrangement with captives formed by other peer sized community banks to mitigate further and distributed the bank’s risks. The group of community banks that formed captives joined into a reinsurance agreement with peer banks, and the programme is known as the “Bank Captive Programme”, which is managed by KeyState Captive Management. Over the life of the program, 90 community banks from 23 states formed captives and participated in the structure.
CR: What is the value of captives to the entire banking sector?
DF: The value of the captive is to provide reinsurance for measurable risks that are not covered otherwise by commercial insurance. As deductibles have risen due to the growth of the company, the coverage at LCB Risk Management, Inc. has increased to cover the higher deductibles, thus keeping the risk of loss at an acceptable level for the bank and at a reasonable cost.
Removal of the captive insurance company would result in heightened risks that would not be economically feasible to insure, which could have a negative impact on earnings in the event of a loss that was previously covered by our captive insurance structure. In addition, the bank would be exposed to the potential for increased losses in the event of having to cover higher deductibles.
LCB Risk Management, Inc., currently provides the following coverages for the bank and its subsidiaries:
- Various property deductibles, difference in conditions and excess coverages
- Pollution liability coverage
- Financial institutions bond, crime bond deductible reimbursement, excess and difference in conditions coverage
- Workplace violence coverage including loss of key employees due to death, disability and voluntary termination
- Restoration of reputation coverage
- Management liability coverages including professional liability deductibles, cyber coverages (excess and difference in condition), and loan origination fraud
CR: How do micro-captives allow smaller community banks like yourselves to compete with the larger national banks?
DF: As a community bank, we use the captive as a crucial tool to mitigate and distribute our risks and protect against catastrophic risk having a substantial, negative impact on our bank’s earning or capital. The captive also helps us remain competitive with large, national banks, many of which have captive insurance structures, although their premium levels are too large, so they do not make the 831(b) election.
One of the most significant benefits for community banks is their participation in the KeyState bank captive programme allowing peer-sized community banks to share certain risks, which helps mange and mitigate those catastrophic losses, ultimately allowing community banks to keep our costs low to our customers.
CR: How would your captive be affected by the IRS’ new proposals on determining which 831(b) microcaptives are listed transactions?
DF: Our captive would likely be dissolved under the recently proposed Internal Revenue Service Regulation 109309-22. Our profit and loss would be negatively impacted by the dissolution of the captive. We are not interested in continuing to operate our captive as a ‘listed transaction’ as the IRS has proposed. For this reason, we will likely discontinue out bank’s captive under the proposed rules.
CR: Why are the proposals so problematic?
DF: The proposals are problematic because the captive utilised by community banks have proven to mitigate risk. Since the Bank Captive Program was launched in 2012, 90 community banks from across the United States have formed a captive and participated in the programme. KeyState, the manager of the Bank Captive Programme, has processed over 4,400 claims, totalling approximately $93.5 million for programme participants. Of those 4,400 claims filed by KeyState, 185 claims totalling $20 million have benefited from the reinsurance arrangement. The captive and reinsurance arrangement has had a significant impact on Lake City Bank and the other community banks participating in the programme. LCB Risk Management Inc., was greatly beneficial as our bank navigated the challenges of COVID-19 when most commercial carriers denied coverage. In total, participants in the KeyState Bank Captive Programme submitted over $5 million in claims related to COVID-19 losses/costs which were approved and processed by the professional licensed claims administrator.
CR: Were your captive to be deemed a listed transaction, what would be your next steps?
DF: We would close our captive if is deemed a listed transaction as the cost of insurance without the election would no longer achieve the cost-benefit we receive today under this election for risks that are not covered by or are not economically feasible to insure through our commercial carriers.
CR: Would owning a captive still be valuable to your business if you couldn’t take the 831(b) election? And how would it affect Lake City Bank?
DF: No it would not since the premium deduction helps to fund the structure.
CR: What in your opinion would be a fairer way for the IRS to identify companies that are abusing the 831(b) election purely for tax purposes?
DF: A fairer approach for the IRS would be to review individual programmes that have not been used to mitigate risk. The claims experience provided by community banks demonstrates the true business need and adherence to the tax requirements for the reinsurance programme.
We have indicated that we do not object to the continued filing of Form 8886 to identify our captive transaction as “a transaction of interest”. We firmly believe that our captive is being run for the right reasons, to help mitigate risks, and third-party risks, as we adhere to Revenue Ruling 2002-89 (whereby the captive insures over 50% third party risk) and where its insurance policy premiums are calculated annually by an accredited independent actuary.
CR: Are you actively looking to keep growing your captive and add new lines to it? If so, which lines?
DF: Under the proposed Internal Revenue Service Regulation 109309-22 issued on April 10, 2023, we would not continue to maintain our captive.
In the absence of this proposed change, we would continue to evaluate uninsured risks annually and we would work with the certified appraiser to quantify those risks. Over the past two years, our commercial insurance costs have increased by 48% in 2022 and 35% in 2023. Continued use of the captive would enable us to expand insurable risks in the face of significant rising costs of commercial insurance.
