Private Client analysis: For several years corporations have used captive insurance companies to provide risk mitigation. High net worth (HNW) families have varying significant assets that are required to be insured and those families should be able to utilize captive insurance companies to provide them with risk mitigation, and a transfer of assets to future generations. Because captives are licensed, regulated entities, they are legally independent from any other entities. This permits the formation of captives in executing a long-term estate plan or to protect certain assets.
Written by Wayne Fields, President, and Justin Cole, Vice President of the DGM Financial Group in Barbados.
What is a captive insurance company?
A captive insurance company is a wholly owned subsidiary insurer formed to provide risk mitigation for its parent or related entities.
There are many reasons for a company, family business or trust to establish a captive company:
- the parent company is unable to find a suitable traditional insurer to insure it against particular risk
- premiums paid to the captive can create savings to the parent or related entities
- a captive can place cover with the reinsurance market which its parent cannot
- it can address specific risk not available in the insurance market
- it can fund the deductibles within the policies acquired by the parent
- investment income to fund losses
- greater control over claims
- coverage tailored to meet your needs
- reduced reliance on Commercial insurance
- stabilisation of pricing
Key takeaways
- a captive insurance company is a wholly owned subsidiary insurer that provides risk mitigation for its parent company and related entities
- the benefit of having a captive includes lower insurance cost, may have tax advantages, underwriting earnings, and better control over its insurance coverage
- captive insurance companies can assist when the traditional insurance markets are unable or unwilling to provide the coverage for certain risk or the level of cover that you require
- the captive can purchase reinsurance where the parent would be unable to do so
- the parent will have to capitalize the captive, incur overhead expenses to run the captive and must have the ability to carry the insurance exposure and to satisfy the compliance requirements
Which types of coverage do captives provide?
Captives are not established to underwrite all the risks of its parent. The parent will generally insure its risk within the traditional insurance market and the captive will insure certain elements of the parents’ risk:
- property
- casualty
- product liability
- professional liability
- life
- disability
- directors’ and officers’ liability
- vehicle insurance, both property and third-party liability
Regulation of captives
Captives may be licensed to write some lines of business directly. Other lines of business must initially be written by another insurer that is licensed in the domicile of its parent. The front insurer will normally charge 10% of the reinsurance premium as a fee for that service. Premiums paid to a captive may be tax deductible provided the terms of the policy are reasonable. Please seek advice from your tax advisor.
The captive will have to comply with the regulations as required by each domicile.
Captive managers
Most captive management is usually outsourced to a captive manager located in the jurisdiction in which the captive is domiciled.
Captive managers provide a full service which includes the incorporation and licensing of the captive and managing the captive which includes understanding the insurance, tax, accounting, preparation of Board books and holding of Board meetings.
The drafting of insurance policies is generally the function of an insurance or corporate lawyer; the pricing of the policies is done by an underwriter, an actuary or by obtaining quotes from an insurance company.
Domicile selection
Over the years many jurisdictions have developed, and the major domiciles today are Barbados, Bermuda, Cayman, Guernsey and a number of states in the USA.
While companies in the US domiciles will be subject to corporate tax, most offshore domiciles do not have corporate tax.
Captives in Barbados
While all domiciles will outline the advantages of their own location, Barbados has certain advantages that should be considered during the domicile selection.
Barbados has tax treaties with 45 countries, including, Canada, the UK and the US. While there may be some tax savings particularly with withholding tax on dividends, the Permanent Establishment rules provide greater certainty than domiciles that do not have treaties.
Due to a well-educated population that provides well trained staff in the insurance and other industries, Barbados captive managers do not have to recruit expensive expatriate staff. In addition, due to our weak currency it provides a greater cost saving to captive clients.
Barbados regulatory requirements and incentives
- insurance companies can conduct business in two classes. Class one is for related party business and class two is for third party business
- the minimum capital is US$125,000
- exemption from withholding taxes
- no capital gains taxes
- no inheritance taxes
- Barbados commits to use of IFRS or US GAAP
- incorporation and licensing within six weeks
Solvency
For companies carrying on general insurance business during the first year, the value of assets must exceed its liabilities by US$125,000. After the first year, the company must maintain a solvency margin such that it is at least equal to:
- if the premium income in the preceding year did not exceed US$750,000 then the solvency requirement is US$125,000
- 20% of premium income for the preceding financial year for the premium income up to US$5m plus
- 10% of premium income for the preceding financial year for premium in excess of US$5m
- companies carrying on long term insurance business are deemed insolvent and unable to pay their debts if the value of their assets do not exceed liabilities
Separate account structures
Provided that its articles of incorporation so permit, a corporation may establish one or more separate accounts in respect of a contract liability.
- separate accounts may only be established for insurance companies
- the company must specify in its articles the designation, restrictions, conditions and rights that are attached to any separate account created under the authority of its articles
- the assets of the company are segregated into separate accounts that are kept separate from the general assets of the company
- the assets of a separate account include the specific assets owned by a company allocated and credited to the separate account. It also includes all income, interest, gains, expenses, and losses incurred or earned, in respect of the company’s dealing with the assets that are allocated to the separate account in accordance with the terms of the contract that relate to the establishment of the separate account
- a company that has established a separate account may invest and deal with the assets of a separate account in accordance with the terms of the relevant contract
- separate books of record must be kept for each separate account
Segregated cell companies
The legislation which regulates a segregated cell company (SCC) is applicable to companies carrying on financial services activity, including insurance, banking and mutual funds or such activity of a non-financial nature as approved by the Minister.
A SCC is a single legal entity comprised of a core and a number of segregated cells. Under the legislation governing SCCs, this structure creates a legal segregation of the SCCs assets and liabilities into a number of different cells and a core. Each cell is separate and independent from the other cells, as well as from the core of the company. The undertakings of one cell have no bearing on the other cells; the assets, liabilities and activities of each cell are ring-fenced from other cells. Under this corporate structure, the risks and rewards of one cell are kept separate from those of other cells. Each cell is only liable for its own debts and not the debts of any other within the company.
Other points to note are that the SCC must include in its name Segregated Cell Company or SCC. Furthermore, each cell must have its own distinct designation or denomination which must be clearly set out in the agreement.
How can a family use a captive?
A family which owns a successful company may wish to pass the ownership and earnings on in a tax advantaged structure from the original owner to the next generation. A trust could be established for the benefit of the next generation and the trust could own the captive.
The family can also use the captive to participate in the insurance of high price assets such as property, art and cars.
In addition, HNW families face significant inheritance taxes on the assets that they own. Many of these assets are illiquid and to finance the inheritance tax HNW families may purchase life insurance to cover the inheritance tax. Insuring the HNW family through their own captive allows them to reach the reinsurance market and earn a margin within the captive.
If the captive is considered a trading company in the United Kingdom, there may be some additional advantages for the family.
Taxation of captives
Taxation of captives will vary from country to country, and while there may be opportunities for the deduction of premiums paid by companies to captives, a tax specialist should be engaged for the structuring of the insurance program.
Some countries will have controlled foreign companies’ rules. These rules are generally anti-avoidance rules which are designed to prevent companies from artificially moving profits to a low or no tax country. Again, professional advice is required to navigate these rules.
Conclusion
A captive insurance company can provide the following advantages: risk mitigation solutions; the funding of deductibles within traditional insurance policies; the provision of cover for risks that are unavailable in the insurance market; better control of the claim process; better access to the reinsurance market. For HNW families, a captive company can also be used to transfer wealth to the next generation.
However, consideration must be given to the tax implications as it relates to the deductible of premiums in the parent and any tax consequences on the profits of the captive in the country of the parent.
Wayne Fields is President and Justin Cole is Vice President, of the DGM Financial Group in Barbados.
“This article was first published on LexisPSL on November 8, 2022”