Advantages of Incorporating a Captive in the BVI
- Capitalisation requirements are not onerous and the minimum capital required may, subject to approval, be in the form of cash or letter of credit
- Incorporation costs and insurance licence fees compare very favourably with other captive domiciles. The fees charged by professional advisers also compare well with other jurisdictions
- Applying for an insurance licence is relatively simple and applications are processed quickly
- Most captives are incorporated under the provisions of the International Business Companies Act or from 1 January 2006 the BVI Business Companies Act, which enjoy BVI tax exempt status. There is no income tax, inheritance tax, death duty, capital gains, capital transfer or estate tax in the BVI
- The redomestication of a captive to another domicile is permitted
- While very many people welcome the opportunity to visit the beautiful BVI, there is no requirement to hold board meetings here which can result in considerable savings in both cost and time
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What is a captive?
In its simplest form a captive can be defined as a wholly owned insurance subsidiary of an organisation not in the insurance business whose primary function is to insure some or all the risks of its parent. Since captives were first formed the industry has looked at new ways of developing the captive model to provide appropriate vehicles for a wide range of different owners and users. There are now many types of captives, including:
- Single-parent captives, underwriting only the risks of related group companies
- Diversified captives underwriting unrelated risks in addition to group business
- Association captives, which underwrite the risks of members of an industry or trade association. Structured in a very similar way to Mutuals, these are often created by industry groups or associations to insure risks that are difficult or expensive to place in the commercial market
- Agency captives, formed by insurance agents to allow them to participate in the high-quality risks which they control
- Rent-a-captives, which provide access to captive facilities without the user needing to capitalise his own captive. The user pays a fee for the use of the captive facilities and will be required to provide some form of collateral so that the rent-a-captive is not at risk for any underwriting losses suffered by the user
- Segregated Portfolio Companies (otherwise known as Protected Cell Companies) evolved from the rent-a-captive concept, but they have the added benefit of allowing the participant to place risks in an individual cell in the knowledge that the cell is ring fenced from the liabilities of other cells
A captive may be either a direct writing company or a reinsurer. Particularly in the case of smaller captives, it is simpler for the captive to operate as a reinsurer accepting the risks of its parent, which have been insured by a licensed direct-writing company (a fronting company) and then ceded to the captive. The fronting company will charge a fee for its services and may require a letter of credit to guarantee the captive’s ability to pay claims. Where the risks to be covered can be written by a non-admitted insurer or where the captive is admitted in the territory where the risk is situated, direct writing is possible.
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Why form a captive?
It is popularly thought that a captive is primarily a tax minimisation device. In fact, captives are usually formed for other economic reasons with the main drivers being risk management and risk financing. Some of these reasons are summarised below.
- Lower insurance costs. Commercial market insurance premiums must be adequate to meet the cost of claims but, in common with other commercial enterprises, insurers are in business to make money and will therefore include in the premium an element to provide for their overheads and profit. In establishing a captive, the parent seeks to retain the profit within the group rather than see it go to an outside party. A captive may also help reduce insurance costs by charging a premium that more accurately reflects the parent’s loss experience.
- Cash flow. Apart from pure underwriting profit, insurers rely heavily on investment income. Premiums are typically paid in advance, while claims are paid out over a longer period. Until claims become payable, the premium is available for investment. By utilising a captive, premiums and investment income are retained within the group, and where the captive is domiciled offshore, that investment income may be untaxed. Additionally, the captive may be able to offer a more flexible premium payment plan thereby offering a direct cash flow advantage to the parent.
- Risk retention. A company’s willingness to retain more of its own risk, particularly by increasing deductible levels, may be frustrated by the inadequate discount offered by insurers to take account of the increased deductible and by the fact that the company is unable to establish reserves to pay future claims. Establishment of a captive can help address both these problems.
- Unavailability of coverage. Where the commercial market is unable or unwilling to provide coverage for certain risks or where the price quoted is seen to be unreasonable, a captive may provide the cover required.
- Risk Management. A captive can act as a focus for the risk management and risk financing activities of its parent organisation. An effective risk management programme will result in recognisable profits for the captive. A captive can also be used by a multinational to set global deductible levels by enabling a local manager to insure with the captive at a level suitable to the size of his own business unit, while the captive only buys reinsurance in excess of the level appropriate to the group as a whole.
- Access to the reinsurance market. Reinsurers are the international wholesalers of the insurance world. Operating on a lower cost structure than direct insurers, they are able to provide coverage at advantageous rates. By using a captive to access the reinsurance market, the buyer can more easily determine his own retention levels and structure his programme with greater flexibility.
- Writing unrelated risks for profit. Apart from writing its parent’s risks, a captive may operate as a separate profit centre by writing the risks of third parties. In particular, an organisation may wish to sell insurance to existing customers of its core business. For example, retailers may sell extended warranty cover to customers with the risk being carried by the retailer’s captive. The claims pattern of this type of business is usually very predictable with a large number of small exposures and can provide the retailer with a valuable additional source of revenue.
- Asset Protection. BVI insurers engaged in long term business are obliged by the Act to maintain segregated funds, which are then only available to meet liabilities under policies in respect of which the segregated fund is maintained. Plans can therefore be arranged, often using annuity policies, whereby assets in the fund are protected from other obligations, including judgements of a court. Professional tax advisers are generally involved in establishing such plans.
- Tax minimisation and deferral. Yes there can be tax advantages to using a captive! The tax considerations in forming a captive will depend on the domicile of both the parent and the captive. Integration of a captive as part of an overall tax planning strategy is a complex subject so that professional legal and tax advice is essential.
Captives come in all shapes and sizes and are owned by individuals as well as corporations. Although, the formation of a captive is not for everyone, the scope of captives is much broader than is generally imagined and in appropriate circumstances a viable captive can be formed with a relatively small premium income.
The first step in establishing a captive is to commission a feasibility study from professional advisers. Belmont Insurance Management Limited can provide this service, usually in conjunction with other advisors in the parent’s domicile. The feasibility study should examine risk exposures, loss experience, the existing insurance programme, expected future growth trends at the parent company and all matters which impact upon the decision as to how best to design a vehicle for medium-term risk financing.
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