In this GCP Short, produced in collaboration with Friends of the Podcast Marsh Captive Solutions, Richard is joined by Michael Serricchio, Americas Sales & Advisory Leader at Marsh Captive Solutions, Rich Serina, Senior Manager for Risk Management at Canon USA, and Donna Weber, SVP with responsibility for Marsh’s global protected cell companies.
The trio discuss the growing trend of insureds using captives, and in particular cell captives, to write third party risk. Rich Serina explains how Canon USA has used a DC cell since 2018 to take part in a profitable line of third party insurance.
In episode 50 of the Global Captive Podcast, supported by legacy specialists R&Q, Richard is joined by guest co-host Mike Foley, President of Captive Resources.
Mike joined the group captive specialists in 2018 and discusses his perspective on the risk transfer strategy, his background in the commercial market and the impact of the hard market on group captives.
The captive owner interview is with Dan Scheid, CFO at Zeigler Auto Group and President of Navigator Casualty, Ltd, a Cayman-domiciled group captive. Dan discusses Zeigler’s journey as founder members of Navigator and the benefits it has brought to the company.
For more episodes and to subscribe to the Global Captive Podcast see:
In this GCP Short, produced in collaboration with Friends of the Podcast AM Best, Richard is joined by Daniele Zucchi, Managing Director of Sigurd Ruck, the Swiss-domiciled captive owned by Saipem, Ghislain Le Cam, a Director of Analytics at AM Best, and Roisin Gallagher, Associate Director within Market Development for AM Best Ratings Services.
Daniele, Ghislain and Roisin discuss how and why captives are rated, the impact of the volatile insurance environment and the effect of the parent and other factors on a captive’s rating.
In this GCP Short, produced in collaboration with Friends of the Podcast Swiss Re Corporate Solutions, Richard and guests debate the similarities and differences between virtual captives and protected cell companies (PCCs).
Thomas Keist, Global Captive Solutions Leader at Swiss Re Corporate Solutions, and Fabrice Frere, Managing Director within Aon Global Risk Consulting in Luxembourg, discuss the two structures, addressing areas such as fronting and reinsurance partners, domicile considerations and consolidated and unconsolidated balance sheets.
Jenny Coletta is a Partner and Global Captive Network Co-Leader at EY. Over the last 18 years Jenny has worked exclusively with insurers, providing international insurance tax and transfer pricing services. Jenny leads EY’s Global Insurance Transfer Pricing practice, EY’s Global Captive Insurance network and EY’s UK Insurance International Tax team.
Captives owned by multinational organisations have had to keep a close eye on the OECD’s BEPS project, and further developments are expected this summer that will require close inspection once more.
In July 2021 the OECD/G20 Inclusive Framework[1] of 137[2] countries and the G20 finance ministers are due to reach the next milestone in seeking to achieve consensus with respect to the latest OECD Base Erosion & Profit Shifting (BEPS) project. Widely known as “BEPS 2.0” this project has been underway for the last few years and now appears likely to supersede many aspects of the original BEPS project.
Eight years on from the original BEPS project, which itself had some significant impacts for captives, many jurisdictions are still implementing the initial proposals. Like all good sequels BEPS 2.0 promises to be even more action-packed and ultimately could completely overhaul the international tax system. Most notably for captive owners, the proposals introduce the concept of a minimum tax rate such that multinationals owning entities in low and zero tax jurisdictions may be subject to a top-up tax up to an as-yet undecided minimum tax rate. This will result in a fundamental shift in tax policy for many of the countries expected to adopt the rules.
So, what does this mean for captive owners? Will this result in a significant rise in tax cost? Will captive owners undo what they have put in place as a result of BEPS 1.0?
We explore some recent trends in the captive market and where the future path might lead considering these new developments.
Timing is everything….
Of course, we should not lose sight of the fact that at the same time, and probably of far greater concern for multinationals is that the commercial insurance market has been and is continuing to harden at levels not seen for decades. Many risk directors are facing astronomical pricing hikes for coverage. In certain industries some are facing portfolios of uninsurable risks. Many groups that have not previously owned a captive are now considering doing so. Groups with existing captives are considering increasing retentions. Brexit may bring regulatory challenges to the commercial insurance market which could also further exacerbate operational costs reflected in programme pricing.
So, the need for a captive is probably greater than ever. New and existing captive owners may therefore need to keep a close eye on these potential tax changes which could bring additional tax cost.
Déjà vu??
In the context of the OECD proposals, this is not the first rodeo for many captive owners. We saw under the original BEPS project that the drive for more substance in captive locations led to captive owners reconsidering their strategy – faced with increased operational cost it often made sense to increase the scale of the captive through writing more business. We also saw other BEPS actions lead to more scrutiny on the transfer pricing of captive arrangements and the need to support the commercial rationale; this resulted in behavioural change as smaller, less commercial captives became unsustainable.
Particular tax challenges included changes to Controlled Foreign Company (“CFC”) rules, the UK Diverted Profits Tax (the UK legislative enactment of some of the original BEPS actions), targeted transfer pricing rules and increased controversy around transfer pricing of captive arrangements, and of course the US Tax Reform (The Tax Cuts and Jobs Act of 2017) introducing the Base Erosion and Anti-Abuse Tax, or BEAT.
All of these pressures may have played some part in the overall movement in the total numbers of captives in 2016-2018 as smaller, less commercial captives became unsustainable. However, the volumes of premium written and assets under management became larger as captive owners used their increased substance to write more risk.
For some captive owners these tax challenges presented too much uncertainty and, potentially, reputational risk. Some captive owners instead opted to pay more tax by taxing their captives in the parent location thus mitigating many of these areas of challenge. In many OECD countries this can be undertaken by moving the “central management and control” or “place of effective management” of the captive to the parent location. This generally entails having some substance through holding board meetings in the parent jurisdiction, instead of in the captive location.
This concept originally derives from case law but was latterly enshrined in OECD Model Tax Convention guidance around 20 years ago. It is followed in many countries, however, the most notable exception to this is the US which does not currently observe this concept. However, as an aside, it should be noted that some members of the US Congress have again introduced a proposal for legislation that would refer to this concept of management and control being an indicator of residence, though it remains far from clear whether this proposal will be seriously considered later this year as the US Congress considers numerous international tax law changes aimed at raising revenue to help fund new spending on infrastructure and other programs.
In any case, the US already has a mechanism in place which allows certain insurance companies to be elected as US taxpayers, which has the same effect.
What next?
Broadly speaking, if the BEPS 2.0 proposals are implemented into local law, captive owners holding captives with an effective tax rate below the proposed minimum tax rate will be subject to tax in the parent jurisdiction on the profits of the captive at a ‘top up’ to the minimum rate. For those multinational corporations whose parent jurisdictions do not adopt this top up tax, a back-stop proposal somewhat like the US BEAT could be used by other countries to deny deductions for payments to low-tax jurisdictions.
These rules are intended to operate after the various other international rules mentioned above. However, this does bring into question whether some of the existing substance-based rules will become obsolete if captive owners will be subject to tax in the parent location anyway. Since the substance rules were initially introduced to change behaviour and substantiate commercially rational conduct it would be unfortunate if the new BEPS rules simply disregard that.
How, when and whether the rules will actually be implemented in various countries remains to be seen. Many commentators would observe that there are some significant political barriers to be overcome in doing so, not least ensuring relief for double-taxation and dispute resolution. For the previous BEPS Actions this was achieved (after a lengthy process) through a Multilateral Instrument essentially designed to overlay approximately 3,000 double-tax treaties globally in place and signed up to by many jurisdictions. However not all countries signed up to this and implementation has been inconsistent.
We would also expect the EU to publish its version of the proposals and could expect to see local countries issuing their own consultations later this year or next year. Captive owners should continue to monitor the situation.
This Publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Member firms of the global EY organization cannot accept responsibility for loss to any person relying on this article.
[1] In 2016 the OECD/G20 Inclusive Framework on BEPS (IF) was established to ensure interested countries and jurisdictions, including developing economies, can participate on an equal footing in the development of standards on BEPS related issues, while reviewing and monitoring the implementation of the OECD/G20 BEPS Project [https://www.oecd.org/tax/beps/flyer-inclusive-framework-on-beps.pdf]
[2] As at 21 January 2021 – https://www.oecd.org/tax/beps/oecd-g20-inclusive-framework-on-beps-to-meet-at-plenary-level-on-27-28-january-2021.htm
This GCP Short, produced in collaboration with Friends of the Podcast Morris, Manning & Martin LLP, explores the key considerations for captives and their owners when there is merger and/or acquisition activity at the parent level.
Joseph Holahan, partner in Morris, Manning & Martin’s insurance and reinsurance practice, and Lisa Willits, owner of Captive Advisory Partners LLC, discuss the due diligence concerning captives that is recommended when an acquisition is taking place, change of ownership regulations, strategies to consider when multiple captives are at play and the process involved for merging existing captives.
Hard market conditions drove Knauf’s decision to form a Luxembourg captive, according to Marcus Reichel, head of insurance at the German multinational building materials supplier.
“This is something [the hard market] which helped to speed up the process in our decision making within the group,” he explained on GCP #49.
Reichel said that despite the company having good loss ratios, it was ultimately suffering from “unreasonable” premium increases as a result of hard market conditions.
Knauf, a privately owned company, already has a Vermont-based captive in operation since 2018, which in inherited from an acquisition.
The captive which writes medical stop loss and terrorism and funds self-insured retentions (SIRs) for other property and casualty lines.
The Vermont captive is also looking to write workers’ compenstation and fund life and disability insurance when the time is right.
“Since we have a decent US operation, we see the value in keeping it and even expanding it,” he said.
Reichel discussed the formation of the company’s second captive is Luxembourg and was asked whether Germany was ever considered as the company’s domicile of choice.
“As long as we’re not having a a specialised captive management company here in Germany, we should pick up the knowledge we get from outside of our group,” he explained.
“And therefore, we really looked into these hotspot locations like Dublin, like Luxembourg, rather than going back to Germany.”
Reichel said the company selected Luxembourg as it most appropriately fitted its “needs”.
“And also because of various other aspects like the quality of knowledge of captive management, and proximity,” he said.
In the “first phase” of the company’s new Luxembourg captive, he explained that the company was going start by writing P&C risks.
“We are taking some retentions and giving the insurer the chance to front our policies and take the excess risk,” Reichel added. “But the majority of risk for both the property and casualty programmes are kept with us.”
He said that based on the company’s loss ratios, it had an opportunity to improve its cost base and make the risk management function much more visible within the group.
In GCP #49, supported by legacy specialists R&Q, Richard is joined by guest co-host Adrian Lynch, who recently joined Artex Risk Solutions from Aon as executive vice president with responsibility for operations and business development in the Americas, Bermuda and Cayman.
Adrian discusses Artex’s immediate plans including potential further acquisition activity, the impact of the pandemic on healthcare captives and the captive response to the hard market.
The captive owner interview is with Marcus Reichel, head of insurance at Knauf, a privately-owned Germany building materials company. Knauf own a Vermont captive and have just recently formed a Luxembourg reinsurance captive.
And Chris Dalziel, executive director, and Mike Trudeau, portfolio analyst, from Friends of the Podcast London & Capital provide us with the Q1 investments update.
The United Kingdom could be the next European country to introduce a regulatory framework for captives after the London Market Group (LMG) stepped up its discussions with the government on the topic.
Captive Intelligence understands the government is looking for “quick Brexit wins” and views captives as one option that could easily leverage London’s existing reputation as the world’s leading reinsurance centre.
Discussions are at an early stage, but there is a strong appetite within the LMG to make progress. One option would be to open up protected cell companies (PCCs) to permit their use for captive business. PCCs were introduced in the UK when regulations for facilitating insurance linked securities (ILS) came into force in 2017. Currently they only allow their use for ILS business, however.
It remains to be seen whether UK captives would have to follow the EU’s Solvency II regime. Bermuda’s success in achieving Solvency II equivalence for its commercial (re)insurers, while keeping captives outside of the regime, has set a precedent that the UK could seek to replicate.
The proposals being discussed by the LMG and the UK government are separate to those under development at Lloyd’s. Captive Intelligence understands a pilot scheme for applications to form a ‘Captive Syndicate’ within Lloyd’s could be opened as soon as May and the market will be looking for ideal candidates to take part.
Oliver Schofield, managing partner at independent captive consultancy RISCS, is excited at the prospect of being able to use Lloyd’s to facilitate captive business.
“The most attractive aspects of captive syndicates at Lloyd’s will be the ability for a captive to be able to issue policies globally wherever Lloyd’s have local licenses,” he tells Captive Intelligence.
“This is a value that Lloyd’s brings to all syndicates and captives will be included in that. In addition, a captive syndicate will automatically be a rated entity. Both of these are benefits that are being sought by captive owners.
“I think the interest will come from larger multi-line captive owners and prospective owners. The cost base is likely to be less attractive to mono-line captive owners who currently use a cell structure.”
Concerning the news the LMG is exploring the introduction of a regulatory framework for captives in the UK, Schofield adds: “If UK domiciled captives were required to adhere to Solvency II rules then I believe that would effectively kill off any interest.
“Secondly, the UK would need to allow cells as well as pure captives. More and more mid-size companies are establishing cells rather than pure captives so this will be critical for a successful UK captive product.”
As France, Italy and the UK consider introducing their own captive framework, should captive owners be careful what they wish for?
Guernsey, Luxembourg and Dublin have long dominated Europe’s captive landscape as far as domicile choices are concerned. In the main, European businesses, including those in the UK, have looked to the specialist centres to domicile their captives and it has been a successful strategy.
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