By Don Ray, Portfolio Reinsurance
If you just bought your new dealership or are considering buying or selling a dealership, now could be the time to make some important profit opportunity decisions. Reinsurance is an off-statement area that is often overlooked but could be a profit center.
Reinsurance is a great opportunity to participate in some (or all) the underwriting from the insuring of F&I products such as vehicle service contracts (VSC), guaranteed asset protection (GAP) policies and, depending on the administrator, a plethora of other products sold by a dealership’s F&I department.
It may be a factor when a seller is determining the blue sky for his/her dealership. It also may be a factor when a buyer is deciding how much to pay. In either case it is always wise to be educated about the many factors involved in putting a value on a car dealership.
What is reinsurance and how can I be involved?
Reinsurance is the transfer of risk of claims from one insurance company (the front carrier) to another insurance company (your reinsurance company). When a consumer buys a VSC (or other reinsured product), a contract is entered into between the consumer and the front carrier (also referred to as direct writer) which is a large insurance company and is licensed in the applicable state. The direct writer cedes (transfers) the business to the reinsurance company (your company). Consumer claims are then paid by your reinsurance company.
Typically there are two ways to participate in this underwriting income through reinsurance. First let’s discuss the use of non-controlled foreign corporations (commonly referred to as an NCFC). By definition no one person can control an NCFC. An NCFC must have at least 11 unrelated US taxpayers as shareholders. You should also be aware they are subject to the Foreign Account Tax Compliance Act (FATCA) requirements.
NCFCs are truly foreign corporations whose assets (cash) are maintained outside the United States and are managed by an administrator. Since the assets are kept in a foreign country, it is important to understand the stability of that country. Dealer/owners do not direct the operations or investments of these corporations. In this type structure, the dealer/owner shares risk with other dealer/owners in this NCFC.
These type companies pay no United States income tax. However, when a US taxpayer receives a distribution from an NCFC, the distribution is subject to ordinary income tax rates and depending on your income level the Net Investment Income Tax (“Obamacare surtax”).
This structure can be useful when premium dollars earned are in excess of the $1.2m threshold for controlled foreign corporations (and in the event the dealer is unable or unwilling to form multiple controlled foreign corporations within the rules surrounding “control groups”) and also when the dealer/owner does not wish to participate in the operations of the company but would rather leave that to others.
Now what about controlled foreign corporations (commonly referred to as a CFC). These companies are incorporated in a foreign jurisdiction but elect to be taxed (unlike an NCFC) as a US taxpayer under IRC 953(d) and further elect to not be taxed on underwriting profits under IRC 831(b).
Under these Code provisions, as long as the electing company receives less than $1.2m in annual premium income, it only pays tax on its investment earnings (i.e. dividends, interest, etc.) and not ever on the underwriting or operational profit of the reinsurance company. These CFCs are typically the structure of choice for most auto dealers. A distribution from this type company to a shareholder is taxed to the shareholder as a “qualified dividend” subject to a lower federal tax rate than ordinary income would be. Depending on your income level the Net Investment Income Tax could be imposed as well.
Of course, participation in the underwriting and investment opportunities of reinsurance is meaningless if little to no product premiums go into the reinsurance company. Below is a partial list of F&I products that potentially can be reinsured for new and used vehicles.
- Vehicle Service Contracts
- Powertrain Contracts
- GAP
- Maintenance
- Tire and Wheel Protection
- Paint Protection
- Body Code (generically referred to as “Etch”)
- Dent
- Key Replacement
- Certified Pre-Owned (CPO)
- Lease Products
- Glass
- Fabric Protectant
Many of these same products may be reinsured for RV’s and motorcycles as well.
While the tax aspects of all NCFCs are the same and the tax aspects of all CFCs are the same, oftentimes that is where the similarities end. The variation in the amount of control and flexibility allowed by various administrators vary greatly so be sure to do your homework before selecting one or ignoring the opportunity completely!
Don E. Ray works at Portfolio…THE Reinsurance Company for Auto Dealers. He can be reached at 917-359-5128 or dray38138@gmail.com
