The inaugural Participation and Reinsurance Symposium took place at Caesars Palace in Las Vegas on Monday, March 4, as a bonus event prior to the Agent Summit. By all measures it was a huge success. In the months leading up to the Symposium, its viability was questioned by some agents; after all, isn’t reinsurance as a topic about as exciting as watching paint dry? Not so. After the strong audience reaction to last year’s presentation on reinsurance by Randy Crisorio and Greg Petrowski, it was clear there was interest in an expanded treatment of the topic. And as chairman of the Agent Summit Advisory Committee, Crisorio was in a position to make sure it happened.
When it finally came to pass, the room — with seats for 400 — was overflowing, and remained so for the duration of the program. Additional seats were brought in to accommodate the attendees left standing in the back, but even these were not enough to give everyone a chair. Clearly, the organizers had hit a nerve.
Retros, Dealer Obligors and Dealer-Owned Warranty Companies
Mark Macek, president of United States Warranty Corp., got things started with a presentation on three types of profit participation programs: retros and dealer-owned warranty companies (dealer-obligor and administrator-obligor).
Retro programs are normally a provision of dealership commission agreements, whereby dealerships receive some portion of the underwriting profits and investment income associated with the sale of F&I products. On the plus side, retro programs are easy to administer, and involve no hassle for the dealership. All the dealership needs to do is sell product and collect the program revenue.
But there is a downside to retro programs. Foremost and first, the possibility of building wealth outside of the dealership structure is absent. Administrators typically retain some portion of the investment income, so dealerships don’t get to keep all of the profits their premium dollars generate. Under retro programs, dealerships don’t control claims payments — administrators do — and they are bound by the provider’s rate schedule. Also, there are usually vesting and volume requirements in order to be eligible for retro programs.
Macek also expounded on the two types of dealer-owned warranty companies: dealer-obligor and administrator-obligor. Both varieties generally involve a contractual liability policy to limit potential exposure for losses. But under a dealer-obligor structure, the dealership itself assumes the risk. And while the dealership ultimately controls payment of claims, dealerships in this arrangement almost always utilize a third-party administrator to perform those tasks. Under an administrator-obligor structure, the administrator issues the contracts and assumes the risk associated with them.
The obligor is a separate legal entity from the dealership itself, even if those entities are under common ownership. The status as distinct legal entities has profound tax consequences. Under a dealer-obligor structure, revenues cannot be accounted for under an insurance methodology. Income must be accounted for as regular dealership income, whether as a C corp., S corp., LLC or partnership. The advantages of a dealer-obligor structure include flexibility with respect to rates and claims payments, and the dealership retains all profits flowing from underwriting and investments.
The primary disadvantage of this structure is liability: the dealership itself and its assets are at risk if claims or lawsuit awards exceed reserves. There are also significant tax considerations. And finally, not all states allow this structure.
An administrator-obligor company, being a separate legal entity from the dealership itself, is liable for its own taxes. But those taxes are computed as an insurance company for federal income tax purposes. (Such companies are not considered insurance companies for state tax purposes, but that’s beyond the scope of this article). Distributions are treated as dividends, historically taxed at a lower rate than that of ordinary income. And administrator-obligor companies create a flexible tool for estate planning purposes.
Macek concluded with the sage advice that one size does not fit all. But with the input of qualified tax and legal consultants, the right choice can be made to benefit the dealership and its owners. The important thing is that dealers ask the question, “How can I best maximize the profits flowing from sale of F&I products at the dealership?”
Controlled and Non-Controlled Foreign Corporations
Macek was followed by Steve Mailho, president of the Mailho Co. He brought with him the experience of setting up over 4,500 controlled foreign corporations for dealers over the past three decades, and expounded on the genesis of controlled foreign corporations and the advantages of such structures. With its benefits come risks, such as losing its overseas-company tax status. And perhaps the risk to its tax status flows, in part, from the terms the industry so casually employs, such as “controlled foreign corporation.” If the offshore corporation is, in fact, “controlled” by the dealership or the dealership ownership, is it proper to consider it “foreign” for tax purposes?
“Everybody calls it a ‘CFC’ because it’s the opposite of a non-controlled foreign corporation, or NCFC,” Mailho said. “In our industry, we have often abused acronyms that mislead the IRS into mistaken judgments.” The key difference, he explained, is that while the overseas company is a CFC for an instant in time, it loses that tax status when it becomes a United States Taxpayer.
Mailho went into some detail about what actions are considered “domestic” and, therefore, taxable. Bottom line: take care and seek competent counsel. And, per Mailho, stop calling them CFCs! A more accurate acronym would be ARC, for Associated Revenue Company. But given the strength of tradition, it is likely that Controlled Foreign Corporation as a term is here for the long haul.
The first person to disagree with him on that point was was Steve Barrett, executive vice president of Resource Automotive. Barrett offered a presentation on Non-Controlled Foreign Corporations, or NCFCs, and delivered practical insight into how to keep NCFCs non-controlled, while at the same time keeping one bad dealership’s cell from contaminating the rest of the members. The take-away was that for NCFCs to be successful, there needs to be thorough pre-admission screening — not every dealership is up to the level of integrity and professionalism to be a good risk in a shared pool of liability. And NCFCs need to be managed by a skilled team. While there are great rewards for doing it right, there are tremendous penalties for doing it wrong.
Investing the Cash
Bermuda native Hugh Barit, CEO of PRP Performa Ltd., concluded the formal presentations with a discourse on investing the income. Barit made the arcane understandable — many came into the Symposium not knowing what an asset allocation strategy was, but left knowing what it was and why it’s important.
But the Symposium wasn’t finished yet. SouthwestRe sponsored a prize drawing for agents in attendance. Jim Smith, CEO of SouthwestRe, selected the lucky winner: David Frisbie, president of Profit Portfolio. The grand prize? Two round-trip tickets to the Turks and Caicos Islands.
