Table of Content
- Executive Summary
- Definition of Captive Insurance
- Types of Captives
- Captive Roles
- Impact of Australia’s DOFI legislation on the company decision
- Addressing the ‘Admitted’ vs. ‘Non Admitted’
- Guernsey Plus-side
- The Non-EU Status of Guernsey
- The Advantageous Legislative Design
- Conclusion & Recommendation
- A class of insurance that the captive can’t cover
This report on opening a captive insurance company by an Australian business strives to zero-in the most favourite captive location out of the four provided domiciles. It introduces the topic of captive insurance by referring to the economic ups and downs and increasing premium rates charged by commercial insurance companies as a reason why the trend of captive insurance is catching up. The introduction section identifies captive insurance and stresses the need for different business risks to be covered.
Along with the type of insurance business undertaken by them, with different captive roles, various types of captive insurance are described. As the business group is Australian, the report discusses the impact of Australia’s DOFI legislation on the fairness of the company’s decision to operate a captive unit in preferred locations, including Australia, Guernsey, Bermuda, and Singapore, for the company’s insurance needs. In addition to evaluating each listed domicile destination, numerous similar sub-topics such as ‘Admitted’ and ‘Non-Admitted’ are addressed so that the most suitable domicile is finalised.
Other domiciles are discussed in detail, starting with Australia. Guernsey takes the lead because the long-term strategic risk management planning for an Australian conglomerate keeps maximum favourable points in mind. It concludes by pointing out the distinction between captive insurance undertakings and other insurance undertakings, as captive insurance undertakings cannot cover such insurance coverage.
Rising world economy worries and random highs in commercial insurance rates have prompted firms from different sectors to prepare their own captive insurance agencies. Companies in a number of sectors are gradually leveraging captive insurance as one of their plans for risk management. These businesses are vulnerable to multiple threats and uncertain conditions and, as a general rule, it is not feasible for them to seek insurance cover for certain risks because of the large commercial costs and the inability to provide insurance cover for such industry-specific risks. Financial services, healthcare service providers, retail and consumer goods firms, and infrastructure companies, primarily manufacturing, electricity and utilities, are the four major industries worldwide in terms of the number of captives created. Bermuda and Guernsey are some of the chosen destinations in the sense of the range of captives domiciled on a foreign basis, while Singapore has also eased its captive home programmes (Research and Markets, 2013).
The leading reason behind financial institutions opening maximum captives across the globe, (nearly 20% captives are opened by financial companies) is due to their risk controlling capacities and the need of fulfilling Basel II/ III standards, compelling them towards the higher use of captives. According to Research and Markets (2013), captive domiciles like Bermuda and Guernsey have agreed not to follow parameters equivalent to Solvency II (Research and Markets, 2013).
Definition of Captive Insurance
In summing up general terms, a captive insurance company can be defined as an entity registered in a specific jurisdiction or domicile mainly to insure or reinsure the risks of the parent conglomerate and /or one or more than one other entities, or even not-related entities. So far as all of a captive’s operations are considered wise and within the limit of the law and routine insurance company practice, it can write nearly any kind of insurance cover for relevant or non-relevant entities and ask a premium that the company and its regulators find agreeable (England et al., 2007).
According to Ong Chong Tee, Deputy Managing Director of the Monetary Authority of Singapore (MAS), “As Asia is poised to adopt more advanced risk management solutions, captive insurance will have a role to play,” he said at the Asia Pacific Rendezvous. By the way, in 2007, Singapore’s captive industry reported gross premiums of approximately S$750 million, comprising 22 percent of Singapore’s commercial offshore insurance fund (Marsh, 2008).
Types of Captives
- Pure Captive – is totally owned by one parent company. It is designed basically to insure or reinsure the risks of the corporate parent or non-related parties of the choice of the parent corporate entity.
- Group Captive – is possessed by two or more than two entities, which can be generally trade associations or companies of the same kind. These insurance companies are structured to insure or reinsure the risks of the group.
- Rent-a-Captive (Cell Captive) — formed to insure or reinsure the risks of unrelated shareholders; the insureds are “renting” potential of the insurer leveraged by outside sponsors.
- Risk Retention Group – functions like a group captive but is controlled under federal legislation. It can operate in any state but needs to be licensed in its state of domicile. Insureds and owners must be the same entities. These can write only liability lines of risk and are not capable of offering reinsurance (Wischmeyer et al., 2002).
Pure and group captives can conduct all types of insurance business including:
- Third-party business
- Life insurance
- Joint ventures (Lowe, 2008)
Based on captives’ roles, they can be categorised as:
- Sponsor Captive Investors (acts as SPV)
- Captive able to operate under capital market (ISDA) and insurance validation
- Third party captive owner
- Captives situated in all appealing locations and controlled as insurance companies
- PCC cells provide cost-effective, fast established SPVs → commoditisation
- Captives can also shift banking risk into insurance Product (Watson, 2008).
Impact of Australia’s DOFI Legislation on the Company Decision
As stated, the Australian business house has a yearly income of more than $10 billion. Its two leading insurance programmes are costing it $40million in premium. DOFI legislation for proposed exemptions stipulates certain conditions related to high value insureds. One condition out of various others is related to consolidated gross operating income, which must be $200 million. In the case of the Australian business, it fulfils this condition as its annual income is $10billion, as stated above (Robinson, 2007).
Another stipulation of the DOFI legislation is related to aggregate level of insurance premium, up to $30 million. This is also clearly met by the Australian company, as already it is paying $40 million in insurance premium per annum. Overall, DOFI legislation does not come in the way of the issue of high value insureds (Robinson, 2007).
Regarding insurance of atypical risks, including such risks as kidnapping, malicious product tampering, war, environment, political, nuclear, satellite and asbestos risks, concern has been raised for inadequacy of this list. Further additions of atypical risks under the DOFI legislation have been proposed, including some of the risks related to international P & I Clubs, total public liability and professional indemnity cover, residual value, clinical trials liability, bloodstock, marine, aviation and aerospace and others (Robinson, 2007).
The next issue before DOFI legislation is related to various customized exemptions, such as criteria, assessor, and a list of other exemptions for qualifying specific risks to an authorized insurer. Actually, DOFI legislation is yet to address offshore risks and the need of overseas law (Robinson, 2007).
Addressing the ‘Admitted’ vs. ‘Non Admitted’
The Australian conglomerate desiring to open a captive company on the selected favourable domicile location would be an ‘admitted’ company, as it would be authorised insurer to represent the standard market. Foreign insurers are admitted by a domicile licensing and registration office by providing them license to operate in the domicile admitted market. The domicile office analyses and agrees on other related transactions that affect the license of foreign insurers. A captive company’s transactions are among the leading functions of a domicile licensing authority for offering related services (Texas Department of Insurance, 2013).
On the other hand, non-admitted companies are although registered companies but these insurers represent the non-standard market. When the same type and class of coverage cannot be put in the admitted market with a licensed insurer after a thorough search by a licensed surplus lines agent, as is the case with the Australian conglomerate, it can be put in the non-admitted market with a surplus lines insurer. It is not the scenario with the given Australian company, as it is keen to open a captive unit only and risks are not distinct in kind, not permitting it entry in the admitted market. Generally, the capitalisation parameters for surplus lines foreign insurers are mostly quite higher than the admitted insurers; the regulations are relatively strict (Texas Department of Insurance, 2013).
Before deciding from the four domiciles to locate the captive from among Australia, Bermuda, Guernsey, and Singapore for the Australian conglomerate, an analysis of each domicile on certain parameters is necessary.
Normally, for Australian companies to use the controlled foreign company (CFC)rules, can at the most make the Australian off-shore functions competitive by offering solace to Australian tax-payers from additional attribution taxes and the burden of adherence but not to the Australian businesses leveraging through CFC captive insurance companies (Willis Australia, 2010).
The aim of Australian companies in utilising offshore resident CFC captive insurance companies is primarily to get a competitive edge by purchasing the most cost-efficient insurance programme available. The reason behind opening captives offshore are regulatory (APRA’s changed capital and reporting needs compel Australian companies offshore where regulatory norms are more suitable) and near to global reinsurance centres like Bermuda and Singapore. The main aim of having a CFC captive is to most cost-efficiently finance and shift risk and to operate them near to break-even (surely not with a motive to make bulk profit as insurance is not a basic business for companies using captives) (Willis Australia, 2010).
Insurance premiums paid to captive insurers are computed on the basis of a few leading segments:
- The empirically decided cost of risk to be kept by the business in their owned captive insurance company;
- the reinsurance premiums payable to shift risk in addition to a business’ kept risk to the international insurance and reinsurance markets;
- the facilitating costs (actuarial, audit, regulatory and management) to operate the captive insurance company (Willis Australia, 2010).
The problem in opening a captive company in Australia is that treasury perceives a captive insurance to be an actively organised business; hence the use of new Part 30 Integrity Rule would bring losses to Australian businesses functioning for a captive insurance design relatively to businesses who normally deal insurance via the traditional insurance markets. On the same parameter, the “Grouping Relief” provisions together with “Part 30 Integrity Rule” have the ditto impact (Willis Australia, 2010).
For several years, Guernsey has seen a booming insurance sector. The abundance of knowledge and insight of business specialists is one of the key advantages of the insurance sector in Guernsey, although the market is often beautifully diverse in terms of its members. The ranking of the island as the largest captive insurance home in Europe is well known (Pelley, 2013).
The Guernsey insurance industry has certain leading attributes, which render it very attractive as an insurance domicile. The island has distanced itself from the European Union’s effects. A favourable regulatory framework for insurers has been followed. The demand for insurance in Guernsey is revolutionary. In 1997, it was the first to introduce legislation for the Protected Cell Company, which led to the opening of the market to smaller captives by minimising the entry obstacles (Pelley, 2013).
In Guernsey, a host of sectors, such as accounting companies, law firms, actuarial firms, banks and fund managers, get a comfortable environment from their insurance practitioners. It is impossible to trace in other captive insurance domiciles the density of expertise and insight of the practitioners required in Guernsey. Apart from Bermuda, which has contributed to the rise of global insurance and reinsurance, no other domicile in one area has the same talent depth as Guernsey (Pelley, 2013).
The Non-EU Status of Guernsey
As a smaller and non-EU economy, Guernsey is well positioned to take advantage of economic change from the opportunities that come from a dynamic social and political scenario relative to a larger economy such as the EU, whose market is afflicted by its Member States’ political tussles, recession and financial mismanagement
Guernsey has its own collection of insurance regulations which, as specified by the International Association of Insurance Supervisors, conform to global best practise. More than that, Guernsey follows an elastic approach over these high level codes to help the insurers in getting a competitive edge relatively to their EU counterparts. The GFSC has been keen on creating a customised regulatory mechanism, which is not deficient in any way to the concurrent global parameters, and efficiently controls the regulatory risk of its insurance market (Pelley, 2013).
The Advantageous Legislative Design
Guernsey boasts the Businesses (Guernsey) Legislation 2008, which reinforces and changes the laws of the Covered Cell Corporation, relocation and transfer laws, insolvency laws and a range of other corporate laws to ensure that Guernsey companies will respond to evolving opportunities rapidly and effectively (Pelley, 2013).
In addition to exploiting the Business Rule, the island’s Zero-ten Corporate Tax system is also tax-saving and convenient for insurers to recognise. The corporate tax system for Guernsey insurance is ideal, along with a growing amount of double tax contracts.
Finally, Guernsey has adopted all suggestions on anti-money laundering (AML) by the Financial Intervention Task Force, and it is taken as a ‘equivalent’ jurisdiction of AML and other existing world economies such as Australia and others. Off late, in order to understand the low-risk category of this kind of insurance in regard to money laundering and organised fraud, the regulator in Guernsey distanced himself from the strong line needs for general insurance. It offers Guernsey insurers a strategic advantage to stay on an even basis with other European domiciles on the AML conformity front (Pelley, 2013).
In Bermuda, there are in total 862 captives operating, as per 2011 figures. There are four classes for capitalization needs, the minimum solvency margin. Class 1 requires capital of more than $120,000 or a premium test, requiring first $6million ‘net premium written (npw) or fulfilling the condition of Loss reserve test of 10%. The loss reserve test for Class 4 is 15% while the minimum solvency margin is $100,000,000, with the alternative of premium test, which is 50% of npw (PWC, 2013).
- Liquidity Requirements — Related assets must be equal to 75% of related liabilities.
- Registration and incorporation expenses –– Incorporation fee is $2,600 while BMA Registration fee is $580.
- Investment Limitations –– There are no controls other than that only related assets are permitted for consideration in liquidity computation, excluding investments in funds and intercompany receivables.
- LOCAL Taxes –– There are no taxes till the year 2035 as global firms are assured by the Bermuda government that in case of income or capital gains taxes are enforced, these firms will be relieved from such taxes.
- Tax Treaties –-The Bermuda government has signed a contract with Australia like many other countries, as of March 1, 2013.
- Reporting Needs –– Firms are excused for filing GAAP financial statements. For Class 1 and 2, statutory financial statements are to be filed six months from the year-end, and four months from the year-end for Class 3.
- Loss Reserve Specialist consultation is not needed for Class 1, but is needed tri-annually for Class 2, and each year for Class 3 (PWC, 2013).
Singapore has 63 captives registered and this business is growing at the rate of 2 captives each year added to the list. Considering Singapore for an Australian business to open a captive domicile, there is in force the insurance Act with controls on Valuation and Capital, Accounts and Statements, and Actuaries. Captives in Singapore are exempted under the General Provisions and for Captives regulations, which has the lead effect:
- It demolishes the need from MAS of a statistical report (unless life captive)
- Relieves captives from Risk-based capital needs
- Streamlined reporting (Herbert, 2008).
Singapore offers better tax regime as there is the provision of 10 year tax relief for captive domiciles. Companies can pursue to re-elect for another 10% rebate on the tax rate (Herbert, 2008).
Conclusion and Recommendation
The Australian taxpayer may get a competitive edge by using a CFC captive insurance mechanism, but at the same time he is at a loss from the Treasury’s new Part 30 Integrity Rule, which will not permit tax deduction of the full insurance premium paid to its CFC captive insurer and a lost tax deduction. The outcome for the Australian taxpayers is that it would cost the tax-payer more expensive insurance cover via traditional means because of the tax effect. This may not be the intention of the Treasury as this rule is expected to increase Australian business’ competitiveness (Willis Australia, 2010).
In view of its numerous assets, including its business sponsorship through the Guernsey Foreign Insurance Alliance, the political benefit of the Trade and Jobs Department and the regulator (the Guernsey Financial Services Commission), Guernsey stands at the top as an insurance domicile, both aiming to introduce competition through the launch of innovative goods and services (Pelley, 2013).
A Class of Insurance that the Captive Can’t Cover
Captives are unlikely to cover conventional items from insurance providers such as house, motor, and crop insurance. These types of traditional insurance are covered only by the traditional methodology of insurance, which is about ‘taking and pooling premiums from many to pay the claims of a few.’
Many general insurance firms receive their premium revenue from a number of ‘danger lines’ unlike captive insurance providers, covering, for example, traditional home and car goods through to agricultural and crop insurance (Captive Insurance Solutions of RGIB, 2008).
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