How Effective Are Captive Services?

Captive Services have been a popular means of business process outsourcing for some companies. In this, companies wholly own their BPO units rather than using a third party outsourcing firm. Companies opt for captive services to have complete control on the operations of their business processes in other countries. Again, the main driver is cost effectiveness. Companies tend to shell out more than they would have to pay a third party vendor however a lot less than what they would have to pay in their own country.

Most financial and telecommunication companies prefer having parts of their business processes outsourced in this manner. For example 3 Global services have their captive contact centre in Mumbai, India. Lehman Brothers also had their captive unit in India. The objective of having a captive unit is just to have tighter control and better regulation and functioning of the unit. There are a lot of long drawn legalities around liaising with a third party vendor.

The quality of work can be controlled only to a certain level and the framework of vendor may not be compatible with the company. Hence, using captive services has been an option for companies wanting to outsource since the 1980’s. Some of the companies who spearheaded this movement are British Airways (Captive later known as WNS Global), General Electric (captive later known as GECIS /GENPACT) and AMEX who have their captive units in Delhi and surrounding regions in India. The service arms of Dell, HP, IBM and Accenture have also set up shop in India.

On the other hand, the employees of the captive centres stand to benefit from this sort of a setup. When an employee is working for a BPO, they are indirectly employed by companies that have outsourced their work to them. They may be doing exactly the same work, putting in the same hours and producing the same kind of end product, however they are paid a lot lesser than their counterparts in the west. In a captive service, people are directly employed by the companies and get the same kind of benefits the employees of the company may get in the west. There may be minor differences in their pay scales as compared to the employees in the west; however they pay much better than third party vendors.

The global economic meltdown has not helped these captive setups. Companies like Citibank, Merrill Lynch, BT, Lehman Brothers etc have been forced to shut shop, face bankruptcy and cut down on jobs in many of their captive units. Others have been forced to sell their captives. For example, TCS bought out Citigroup Global Services. In the recent years companies have been forced to rethink their outsourcing strategies as the rising costs have diminished their returns on investments. With most captives attaining maturity and cost effectiveness being a challenge in the face of increasing competition, the future of captive services doesn’t look promising.

Reduce Costs, Plan Your Estate and More With a Captive Insurance

Specifically, captive insurance can help your business clients potentially greatly lower their insurance costs, have more control in managing their insurance, and obtain coverage that might otherwise be unavailable or not affordable. Some forms of captive insurance allow an insured or its assign to maintain an ownership interest in the underlying insurance company. As with any successful business, an owner of a captive can work with his or her advisers to best manage their insurance company. Another potential benefit is that of business and estate planning.

This author stresses that a captive should never be formed unless the primary reason is business purpose. Captives should never be marketed by advisers as “wealth management” or “estate planning” tools. In fact, improper marketing of an otherwise compliant captive can lead to the loss of the captive’s tax status as an insurance company, resulting in taxation and penalties of nearly one hundred percent of premiums.

Yet it is a fact that a successful captive may be useful in business and estate planning. Ownership of a captive may be facilitated by a partnership or trust which is owned, controlled by, or benefits a business owners’ descendants.

As an example, suppose that a business owner (Senior) wants to establish a captive insurance company in order to lower his insurance costs. The insurance company could be owned by a generation skipping trust currently controlled by Senior’s children. The captive’s premiums must be actually verifiable and the coverage must be wholly justifiable. The insurance sold by the captive needs to comport with all relevant statutes from both a regulatory and an IRS standpoint. If the captive’s claims are less than actually anticipated, it may have retained earnings or profits. Depending on the type of captive insurance company, the tax rate levied on underwriting profits can be as little as zero percent. Over time, the insurance company’s profits may be distributed as capital gains, dividends, or even loans to the beneficiaries of the insurance trust. The captive could even provide a funding source for future business opportunities.

The ultimate effect of a compliant and successful captive could be to transfer a portion of the pre-tax premiums from Senior’s business over to Senior’s children, grandchildren, etc., without income, gift, or estate tax. The bottom line for any accountant or wealth adviser is that captives should be looked at as a way to garner significant insurance cost savings with a possibility of secondary benefits.

Again, the author cannot overemphasize the importance that the captive must be designed to and operate as a compliant insurance company. The company must have real losses, real exposure to third party risk, and cannot be in any way an alter ego of or a savings account for the business owner.

Captives can be a tremendous tool helping businesses lower their insurance costs. This author has seen an example of businesses saving millions of dollars in a few short years by properly using captives.

Equally stunning, however, are the adverse tax consequences of an improperly marketed or managed captive. The advisory team chosen for this type work should have many years of captive insurance experience and, ideally, should be supported by a large regional or national law firm.

How to Choose the Best Captive Manager

What is it?

A captive is a type of insurance company that protects the risks of its owner. It pays any claims against the owner’s business. Choosing a Captive Manager can be a daunting task. While there used to be only several major captive management companies in America, recently, several new start-up captive managers have entered the industry and are competing for business.

Here are several things you should look for in order to be confident in whom you choose:

Manager Experience and Staff

A successful captive management requires accounting, insurance, and tax skills. A captive manager and his or her staff should be skilled in these areas. Make sure there are at least a few with appropriate training as evidenced by CPA licenses and insurance background. Also, pay attention to the manager’s individual credentials

  • how long has he been managing?
  • How long has he worked in this field?
  • How many clients do they have currently?

Insurance Expertise

With how quickly technology and industry is progressing, it’s important to keep up to date so that the client’s needs are met. A good captive manager will take the time to understand your business’s risks and propose policies through your captive that solve real risk areas of your business. For example, a policy to cover cyber liability would make sense for a large medical billing office that tracks individuals’ medical and financial records, but may not be appropriate for a small transportation company.

Tax Expertise

A captive insurance company is a tax advantageous way to save funds for a rainy day, and can produce powerful income and estate tax benefits to the captive’s owner as well. You should be comfortable with the level of tax expertise that your captive manager possesses and the approach taken with regards to the IRS rules. Some captive managers take a more aggressive approach and follow a standard based on Federal court cases for structuring their captives. Other captive managers follow the more conservative IRS ”safe harbor” standards with their captives.

A captive manager should explain the pros and cons of each approach to the client.

Services

Another important question to ask is if the captive manager offers all the services you need. Your manager should offer the following services: financial, tax preparation, regulatory, underwriting, management of policy, claims, reinsurance, loss control and cash management. If these services are outsourced and some problems arise down the road, no one may take ownership of your needs.

Communications

Hiring a captive manager is literally the purchase of services. As such, make sure that captive manager is easily accessible and responsive. You should have several options for how to reach the manager. You should also make sure you are comfortable with the people that work for the manager. Make sure they listen and are responsive to you.

Independence

It is always a good idea to hire a captive manager that is independently employed, meaning that the manager does not have to make anyone happy but you. Some managers require that the captive funds are invested under their investment platform (for which the captive manager makes an additional fee). This can lead to poorer service and a lack of independence.

Cost

The fee should be fair, meaning it should reflect the value of the services rendered. Compare prices and watch out for those companies who sneakily increase your costs 5% per year. Some companies charge a flat fee for management, and then add on additional fees for tax return preparation, underwriting, policy issuance, local agent, license fees, etc. Other companies provide bundled captive management, with one fee for everything. Be wary of prices that seem too good to be true. Chances are, the company is just trying to lure new business and has not detailed all the fees involved.

Past Performance

Finally, check into the manager’s past performance. The manager is sure to have a track record. Knowing other clients who have used the manager is the best way to find out how good this manager is.