The Bermuda Market in 2005
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Transcript The Bermuda Market in 2005
www.bermudacaptive.bm
JUN 2 - 4, 2014
An Introduction to Captives and the
Bermuda Domicile
Moderator:
• Peter Willitts, President, Liberty Mutual Management
Speakers:
• Liz Cunningham, Senior Manager, Deloitte Ltd
• Leslie Robinson, Assistant Director, Bermuda Monetary
Authority
• Scott D. Slater, Senior Manager, PricewaterhouseCoopers
• Kent Smith, Associate, Conyers Dill and Pearman
An Introduction to Captives
and the Bermuda Domicile
Agenda
• The Truth About Bermuda
• What and Why a Captive
– Including Actuarial and Consulting Considerations
• Overview of Legal and Governance Issues
• Regulatory Overview
• Tax Considerations Made Simple
The Truth About Bermuda
• 650 miles east of Cape Hatteras, N.C.
• 23 square miles, population over 60,000
• Dependent Territory of United Kingdom
• World’s # 1 Captive Domicile with 862 captives
domiciled at December 31, 2011
• 3rd largest reinsurance market in the world
• Over 30 of the top reinsurers in the world are
based in Bermuda – exceeding the number in any
other country
The Truth About Bermuda
The Truth About Bermuda
So How is it working for the insurance market?
•1960s: Frederic Reiss – Birth of captives in Bermuda
•Mid 1980s: Excess Liability market – ACE, XL
•1990s: Reinsurance market – Hurricane Andrew
•New waves of capital
• 2001 response to September 11, 2001
• 2005 response to hurricanes
• Innovation in Policy Forms, Cell Companies, Captive
Pooling and other specialized commercial vehicles,
such as SPIs and Sidecars
The Truth About Bermuda
How is it working for Captives?
•Almost
100 captives have been domiciled in
Bermuda for over 40 years, and another 300 for over
30 years
•Companies
from over 40 countries spanning the
globe have domiciled their captives in Bermuda
•In
addition to the accounting community, there are
275 professionals in Bermuda with the CPCU or ACII
designations – the largest concentration within a
quarter square mile anywhere
The Truth About Bermuda
General Insurers
• Class 1
266
22.0%
• Class 2
307
25.4%
• Class 3
254
21.0%
• Class 3A
104
8.6%
• Class 3B
16
1.3%
• Class 4
31
2.6%
• Blue means Commercial Insurers
Place Title Here
Long-Term Insurers
• Class A
2
0.2%
• Class B
0
0.0%
• Class C
79
6.5%
• Class D
6
0.5%
• Class E
14
1.2%
• Special Purpose Insurer 55
4.5%
• Dual Licences
75
6.2%
• TOTAL
1209
• Blue means Commercial insurers
The Truth About Bermuda
Comparative Number of
Captives?
Bermuda
Cayman
Vermont
Guernsey
Utah
Delaware
831
759
588
344
342
298
2013 Worldwide
2012 Worldwide
6,559
6,125
What and Why a Captive?
including Actuarial and Consulting considerations
Liz Cunningham, Senior Manager
Deloitte Ltd.
What is a Captive?
An
insurance
company
that provides insurance
controlled
to
by its owners.
and is
Definition
• In essence, a premium funding vehicle for insuring losses of the
parent, or its affiliates, for a specific retention level.
• A financing mechanism that increases its insured’s control over
coverage that can produce a lower net present value cost of risk
financing than commercial alternatives.
• Will be the preferred alternative to risk retention or commercial
insurance if insureds/ owners have
• Ability to retain risk
• Motive (and ability) to pre-fund losses
Characteristics
• Formed to primarily insure, or reinsure the risks of:
• its parent,
• affiliates
• or of a number of parties with risks in common,
• or unrelated risk
• Licensed insurance company
• Regulated under its own legislation
• Usually formed in a specialized environment or “domicile”
– “onshore” or “offshore”
• Licensed only in its domicile and unlicensed in all other
jurisdictions
Types of Captives
•
Single Parent (Direct) Captive:
Parent Company
and Subsidiary
Owned by a single parent and
insuring only its parents risk
exposures
Premium
Captive
Company
Claims
R/I Market
Types of Captives
•
Parent Company
and Subsidiary
Single Parent (Indirect) Captive:
Owned by a single parent and
reinsures (part of) the risks of its
parent ceded by a “fronting” insurer.
Fronting
Insurer
Captive acts as a reinsurer.
Premium
Claims
Captive
Company
R/I Market
Types of Captives
•
Multi/Owner Group Captive:
Owned by more than one parent
and (re) insuring the risks of all
owners.
•
O/I
Association Captive:
Owned by members of a
common industry or trade
association.
This type of captive is designed
to insure the risks of that
industry among its members.
Participation is limited to
members of the association.
*O/I = Owner Insured
O/I
O/I
O/I
O/I*
O/I
Captive
Types of Captives
•
Segregated Account Company:
Cell 2
Each cell is built around a central core
account and insures the risk of a different
owner.
There is no risk sharing between the cells.
Cell 3
Cell 1
Core
Cell 4
Cell 6
Cell 5
Why Form a Captive?
• Benefits come in three main forms:
• Financial
•
Cost Saving
•
Cash-flow
• Risk Management
•
•
Coverage
•
Capacity
•
Control
Profit Center
•
Connected/controlled third party business
Severity
Understanding insurability
Low Frequency
High Severity
High Frequency
High Severity
Low Frequency
Low Severity
High Frequency
Low Severity
Frequency
Is the Risk Transfer and Financing
Paradigm Changing?
Insurable Risk Confidence Level
Insurable Risk Tolerance Level
Retain
Transferable
Transferable
(Material)
Possible
Captive
Retention
Markets won’t
insure or
will charge
excessive
premium
Earnings &
Working Capital
can sustain
losses
Risk Retention Strategy
Earnings & Equity Capital
are sensitive to losses
Risk Transfer Strategy
Identify
Upper
Limit
Equity holders
may be willing
to chance a
loss
Understanding the Market
---
= Captive Performance
Rates High
Losses High
No Market Capacity
Rates Low
Losses Low
Insurance easy to buy
When Does a Captive Make Sense?
• Insurance programs of significant
premium size
• Good loss experience
• Insurance buyer has greater
knowledge and understanding of
the value a captive program can
bring to an organization
• Degree of loss control capability
• Desire for greater flexibility in
program design
• Commitment of senior management
• Clearly defined objectives
• Significant lag between loss
occurrence and payment dates
• Level of risk retention determined
• Co-operation of direct &
reinsurance markets
• Possible tax benefits
• Desire for broader and simpler
insurance contracts
• Anticipation of hard market pricing
• Desire to obtain coverage for nontraditional exposures for which no
other alternative exists
Reasons Not to Form a Captive
• Insurance markets are cost effective
• Unable to make long term or capital commitment
• Inappropriate risk profile
• Tax and regulatory complications
• Insufficient premium volume
• Lack of risk appetite
Types of Coverages
Traditional Lines
• General liability
• Professional and
products liability
• Auto liability
• Director and officer
liability (D&O)
• Employment practices
liability
• Environmental liability
• Workers’ compensation
• Product or service
warranty
• Property and business
interruption
Emerging Lines
• Employee Benefits
• TRIA
• Surety bonds and
fiduciary risk
• Shipping coverages
• Title and private
mortgage insurance
• Property and business
interruption
• Equipment maintenance
• Construction exposures
(OCIPs – Owner
Controlled Insurance
Programs)
• Trade credit risk
Exotic Lines
• Self-insured medical
stop-loss
• Managed care errors and
omissions (E&O)
• Reputation risks
• Intellectual
property/brand risks
• Product recall coverage
• Medicare “fraud and
abuse” insurance
• Integrated risk (earnings
protection)
• Tax audit insurance
• Punitive damages
coverage
Initial Steps To Forming A Captive
• Risk Assessment (Exposures & Appetite for Risk)
• Design
– Coverages
– Limits/Retentions/Deductibles
– Capitalization
– Domicile
• Funding and Feasibility Study
– Expected Losses
– Expenses
– Capitalization
– Pro Forma Financials
– With Business Plan, Basis for the Captive Application
How the Actuary can help
• Project ultimate cost of future loss payments for…
–
–
–
–
–
–
Funding study
Feasibility assessment
Captive design (coverages, limits, retentions etc)
Reinsurance structure
Ongoing reserve setting
Statutory reporting requirements
Data is key!
• Overview of subject business (classes, nature etc)
• Claims triangulations by class
• Individual claims experience (by class / geographical area)
• Historic exposure information (payroll, property schedule etc)
• Financial statements of captive and parent
• Limits and attachment point profiles
• Details of any inuring reinsurance
• Details of any anticipated exposure changes over the next few years
Loss Development Triangles
• These are tables that show changes in value of a group of losses
(either paid or reported) or claim counts over time
• Loss development triangles are typically used to derive expected
reporting/payment patterns
• Example of a reported loss triangle:
Months of Development
AY
12
24
36
48
2008
1,500
2,420
2,720
3,020
2009
1,150
1,840
2,070
2010
1,650
2,640
2011
1,740
• Dimensions in a development triangle:
Rows represent accident years
Columns represent age or maturity
Diagonals represent the valuation date
29
Common Actuarial Methods for
Estimating Ultimate Loss
• Ultimate loss = cumulative paid loss (known) + case reserves (known)
+ Incurred But Not Reported (estimate).
• The relationships among these three components vary tremendously
by line of insurance, by jurisdiction, and by time interval being reviewed
(e.g., recent accident years versus mature accident years). The
relationships also vary from captive to captive depending on the
captives’ claims management philosophies and procedures.
• For short-tail lines e.g. auto liability paid claims and case reserves
typically represent a high proportion of ultimate claims at early
maturities.
• For long-tail lines e.g. medical malpractice or workers compensation,
there is a lengthy period associated with reporting and settlement of
claims.
30
Common Actuarial Methods for
Estimating Ultimate Loss
• Most common actuarial methods include:
Expected loss Method
Loss Development Method
Bornhuetter-Ferguson Method
• No single method can produce the best estimate in all situations.
Actuaries use more than one method and select, using actuarial
judgment, the most appropriate estimate
31
Unique Risks of Captive
• Availability of data
• Quality of data
• Timing differences
• Solvency of other parties (i.e. reinsurers)
• Complex or bespoke programs
Overview Legal & Governance
Issues
Kent Smith, Associate
Conyers Dill & Pearman
Key Governing Statutes
1.Companies Act 1981
2.Insurance Act 1978
-
Insurance Accounts Regulations 1980
-
Insurance Returns & Solvency Regulations 1980
(together, the “Regulations”)
3.SAC Act 2000 (for SACs)
Establishment in Bermuda
• Incorporation in Bermuda
• Merger / Amalgamation into Bermuda
• Continuance into Bermuda
Insurance Act – License Classifications
• General Business
– Classes 1,2 & 3 – Captives
– Classes 3A, 3B, 4 - Commercial
• Long Term (annuity, life accident & health)
– Classes A & B – Captives
– Classes C,D & E – Commercial
Segregated Accounts
• Any general business or long-term insurer wishing to
operate segregated accounts may apply to be registered
under the Segregated Accounts Companies Act 2000 (SAC
Act).
Process to Establish Company in
Bermuda
• Application to incorporate / amalgamate / merge / continue into
Bermuda / register under SAC Act is made to the ROC.
• Beneficial owners (10% + beneficial owners) to be vetted by the
lawyers and approved by the BMA (per Exchange Control Act 1972).
• Application to incorporate can be made separately from the
insurance license application (but is often made in tandem).
• For amalgamations / mergers / continuances / SAC registrations,
completion of the transfer may not occur until the BMA provides its
non-objection to the ROC.
Registration under the Insurance Act
Pre-Licensing Considerations
• Decision made to form captive / re-domicile into Bermuda
• Consideration given to class of captive
• Selection of service providers
• Insurance Manager
• Lawyers
• Auditors
• Banker
• Actuary / Loss Reserve Specialist
Registration under the Insurance Act
Pre-Licensing Documentation
Consists of:
• Business Plan
• 5 year pro-forma financials (Balance Sheet and Income
Statement)
• Pre-incorporation Form
• Parent company financial statements
• Resumes (senior management / directors)
• Acceptance letters for service providers
• SAC Form 1 (if applying for SAC registration)
Registration under the Insurance Act
Pre-Licensing Application
• Application filed with BMA by 5:00pm on Monday prior to ALC
consideration at their weekly meeting the following Friday.
• Four possible outcomes
• Approved
• Approved, but subject [ ]
• Deferred
• Declined
Organising the Company
(a) Meetings to be held:
- Provisional Meeting
- Statutory Meeting
- 1st Board Meeting
(b) Items to be approved:
- Approval of service providers (auditors, insurance manager,
principal representative, resident representative, approved
actuary / loss reserve specialist etc.)
- Bank account opening
- Bye-Laws
Formal Insurance License Application
•
Once required capital is paid into company, Form 1B
(registration application) may be submitted to the BMA.
•
Insurance license may be issued in three days if
application complete.
•
Captive can start writing business once certificate of
registration has been issued.
Insurance Act – Main Provisions
1. Minimum paid-up Share Capital
-
$120,000 for Classes 1,2 & 3
-
$120,000 for Class A
-
$250,000 for Class B
2. Principal Representative and Principal Office / SAC
Representative
– All Bermuda Insurers are required to maintain a principal office and
appoint a principal representative resident in Bermuda (usually the
Insurance Manager).
– SACs must appoint a SAC representative resident in Bermuda.
Insurance Act – Main Provisions
3. Independent Approved Auditor
•
All Bermuda Insurers are required to appoint an independent
approved auditor who will audit and report on the insurer’s
statutory financial statements and statutory financial returns.
4. Actuary / Loss Reserve Specialist (LRS)
-
Class A & B insurers must appoint an approved actuary – must
be an individual-responsible for preparing the actuary’s
certificate filed with annual statutory return.
-
Class 2 and 3 insurers (and Class 1s if required by the BMA)
must appoint an approved loss reserve specialist – must be an
individual – responsible for preparing the LRS opinion in respect
of company’s loss and loss expense provisions in its annual
statutory return.
Insurance Act – Main Provisions
5. Statutory Financial Statements and Returns
-
Every insurer must prepare annual audited statutory financial
statements and submit to the BMA with its statutory financial
return.
-
Rules and guidance for preparation are set out in the
Regulations.
-
Statutory financial statements not prepared in accordance with
GAAP.
-
The statutory financial statements and statutory return are not
public documents.
Insurance Act – Main Provisions
6. Minimum Solvency Margins
An insurer’s statutory assets must exceed its statutory liabilities by an
amount greater than its prescribed minimum solvency margin.
7. Minimum Liquidity Ratio (MLR)
Every general business insurer must maintain the value of its relevant
assets at not less than 75% of the amount of its relevant liabilities.
Insurance Act – Main Provisions
8. Restrictions on Dividends and Distributions
–
Company may not declare or pay a dividend or distribution if it is in breach
of its MSM (or MLR for general business) or if declaration or payment would
cause such a breach.
–
Any company that fails to meet its MSM (or MLR for general business) on
the last day of any financial year is prohibited from declaring or paying any
dividends during the next financial year without BMA consent.
9. Restrictions on Reduction of Capital
No Bermuda insurer may reduce its total statutory capital (as per
previous year’s financial statements) by 15% or more without prior BMA
approval.
Insurance Act – Main Provisions
10. Insurance Code of Conduct
All Bermuda insurers must comply with the Insurance Code of Conduct.
-
Designed to ensure sound corporate governance, risk management
and internal controls are implemented.
Captive Governance
What is Corporate Governance?
• A system of rules, practices and processes by which a company is
directed and controlled.
• Per the Insurance Code of Conduct, every insurer must establish and
maintain a sound corporate governance framework. The framework
should have regard for international best practice on effective
corporate governance. Corporate governance includes principles on
corporate discipline, accountability, responsibility, compliance and
oversight.
The Role of the Directors
•Directors manage the affairs of a company – “mind and will”.
•Appointed by the shareholder(s) on an annual basis.
•Powers generally derive from the constitutional documents of a
company, eg bye-laws.
•Cannot act outside of powers – a company may be able to recover from
its directors any loss to the company arising from acts of the directors
which constitute a breach of their duties to the company.
•Duties are generally owed to the company, not to individual
shareholders.
Board meetings
•
Notice – generally, any director may call a Board meeting at any time on
reasonable notice.
•
Quorum – usually 2.
•
Voting - one man/one vote.
- resolutions are passed by simple majority.
- if allowed in the bye-laws, the chairman may cast a tie-breaker
vote.
•
Personal Interests – whenever a director has a personal interest in the
business of the Company, he must declare it to his co-directors at the first
board meeting where the matter is discussed.
•
Written Consents – anything done at a Board meeting can be done by the
unanimous written consent of the directors (often called a UWR).
Directors Duties
Fiduciary Duties
•
A duty to act in good faith in the best interests of the company (and
not for any collateral purpose).
•
A duty to exercise powers for a proper purpose.
•
A director must not put himself in a position where there is an actual
or potential conflict between his personal interest and his duty to the
company.
•
A director must not take a personal profit from opportunities that result
from his directorship.
Directors Duties
Duty of Skill and Care
• A director must exercise the care, diligence and skill that a
reasonably prudent person would exercise in comparable
circumstances.
• A director must diligently attend to the affairs of the company, but he
is not bound to give continuous attention to the affairs.
• A director is entitled to rely on a subordinate put in a position of
charge for the express purpose of attending the detail of
management. However, directors cannot absolve themselves entirely
of their responsibility by delegation to others.
Regulatory Overview
Leslie Robinson, Assistant Director
Licensing & Authorisations
Bermuda Monetary Authority
BMA - Background
• The Bermuda Monetary Authority Act 1969
• Independent Regulatory Body / Separate from
Government
• Board of Directors
• Integrated regulator of Bermuda’s Financial Services
Sector
BMA’s Main Functions
• Under the BMA Act we are:
• Issuer of Bermuda’s notes and coins
• Manages exchange control transactions
• Regulates & Supervises
• Insurers
• Banks, trust companies, investment businesses, investment
funds, fund administrators
• Money service businesses
• Bermuda Stock Exchange
Regulatory Framework
Supervision
The way in which the rules are applied
Regulation
The rules and conditions
Legislation
The Acts, laws passed by Parliament
The Insurance Code of Conduct
• Builds on previous longstanding practice and guidance for
governance standards, specifically guidance notes on:
•
Corporate Governance
•
Risk Management
•
Internal Controls
• Codifies these existing guidance notes on governance standards
such that they are now legally binding.
• Captive insurers should be mindful of the proportionality
principle in establishing a sound corporate governance, risk
management and internal controls framework
Insurer Class Structure
•
General Business Insurers
– Class 1, 2, 3 – Captive Classes
– Class 3A, 3B, 4 – Commercial Classes
•
Long-Term Business Insurers (annuity, life,
some accident & health)
– Class A, B – Captive Classes
– Class C, D, E – Commercial Classes
•
SPIs (insurer fully funds liabilities through a
debt issuance or some other approved
financing mechanism)
Minimum Solvency Margins
General Business
Class 1
100%
Related
Class 2
<20%
Unrelated or
Multi-owned
Class 3
20% to 50%
Unrelated
a) Minimum Statutory
Capital & Surplus
$120,000
$250,000
$1 million
b) Premium Test: First
$6 million of Net
Premium Written
20%
20%
20%
Net Premiums Written
in excess of $6 million
10%
10%
15%
c) Loss Reserve Test:
Loss and Loss
Expense Reserve
10%
10%
15%
Class of Insurer
Greater of:
32
Minimum Solvency Margins
Long-Term Business
Class of Insurer
Greater of:
a) Minimum Statutory
Capital & Surplus
b) Asset Test: Total
Assets
Class A
100%
Related
Class B
<20%
Unrelated or Multiowned
$120,000
$250,000
0.5%
1.5%
33
Bermuda’s Captive Regulation
• Captive vs. Commercial
• Risk-Based Approach
• Role of Principal Representative and
Insurance Manager
• Insurance Manager On-sites
• Segregated Accounts Companies (Rent-aCaptives)
Pragmatic Approach to Regulation
• Bermuda: The World’s Risk Capital
• Creativity and Innovation
• Modifying accounting regulations/ Section 56
Directions
• Other approvals
• Approving “relevant assets”
• Admitting assets
• Regulations consistent with International
Standards but applied appropriately for Bermuda
Market.
How BMA interacts with service providers
Lawyers
Bermuda
Government
International
Standard
Setting Bodies
Auditors
BMA
Other
Regulators
Banks
External
Actuaries
Insurance
Managers/
Principal
Reps
Captive registrations: by the numbers
Full Year 2013
•91 – New insurers registered (up 72% from 53 in
2012)
•24 – New captives registered (up 100% from 12 in
2012)
•YTD April 2014
•21 – New insurer registrations (up 5% year-on-year)
•4 – New captives registered (flat year-on-year)
International Participation
• The BMA contributes to international regulatory
developments via active participation in international
standard setting bodies, e.g.
• International Association of Insurance Supervisors (IAIS)
• Financial Stability Board’s Regional Consultative Group for the
Americas
• National Association of Insurance Commissioners (NAIC)
• Leadership positions/membership of key working groups and
committees
• Bermuda influences, as well as keeps abreast of, global
regulatory developments
37
International Developments
• Qualified Jurisdictions Status –NAIC
• Solvency II Equivalence – European Insurance and
Occupational Pensions Authority (EIOPA)
• Bermuda’s Anti-Money Laundering Regime –
International Monetary Fund (IMF)
• TIMELINE FOR ASSESSMENTS
• NAIC - 2014
• EIOPA- 2015
• IMF- 2016
International Insurance Tax Planning –
The Basic Principles
Tax Considerations Made Simple
Scott D. Slater
PwC | Senior Manager, Tax
International Insurance Tax Planning –
The Basic Principles
• Determine entity-level taxation
– None if in Bermuda and no elections or activities creating taxable presence
– Elect or operate in a manner to be taxable based upon benefits achieved
• Determine shareholder-level taxation
– Current
– Deferral
– Tax rates
• Determine repatriation plans
– Dividends
– Complete liquidation
– Tax rates
• Consider non-income taxes
– premium taxes, FET, withholding taxes, etc.
How is a Bermuda company taxed?
• Currently, Bermuda does not impose any taxes on
income or capital gains nor impose withholding taxes. As
such, a Bermuda company would not be subject to
income taxation, unless the Bermuda company:
–
–
–
–
has a permanent establishment (“PE”) in a taxing jurisdiction,
engages in a trade or business in a taxing jurisdiction,
is “managed and controlled” from a taxing jurisdiction,
is subject to a gross-level withholding tax imposed by another
taxing jurisdiction, or
– makes an election under IRC §953(d) or (c)(3)(C)
Why is insurance treatment important?
General Rules
• Reserves accrued for retained risks are not currently deductible
for U.S. Federal income tax purposes until losses are paid.
• Fixed and determinable principle
• Economic performance principle (ie, payment)
• Premiums paid to a properly structured captive insurance
company to fund retained risk are currently deductible if the
coverage period is 12 months or less
• if greater than 12 months, the premiums are amortized over
the coverage period
• Amounts received under extended service/warranty contracts are
included in taxable income when received.
Why is insurance treatment important?
Insurance Company Rules
• A captive insurance company can set up deductible insurance
reserves.
• Fair and reasonable
• “Within the actuarial range”
• Insurance premiums received are “earned” over the contract term.
• Insurance premiums can generally be paid across borders to fund
risk exposures and create local deductions.
• A properly structured captive insurance arrangement is generally
accepted as a method of risk management.
What is insurance for U.S. tax purposes?
• The term “insurance” is not defined in the statute or the
Treasury regulations.
• Judicial precedent provides the following framework for
evaluating whether a scenario is an insurance arrangement
(LeGierse):
• Presence of insurance risk
• Risk shifting
• Risk distribution
• Commonly accepted notions of insurance
• Self insurance is not currently deductible.
• Risk shifting was the focus of the courts in response to the
IRS’s “Economic Family” doctrine – which has since been
discarded.
What is insurance for U.S. tax purposes?
• Parent/Subsidiary Risks
Parent
Premiums
Captive
•
Parent has not shifted its risk to Captive.
• Balance sheet approach
• Revenue Ruling 2002-89
•
Premiums paid from Parent to Captive are not deductible.
•
Captive is not considered an insurance company.
What is insurance for U.S. tax purposes?
Brother/Sister Risks
Parent
Subs
Subs
Premiums
Captive
Premiums
Parent
• Parent has not shifted its risk to Captive.
• Balance Sheet approach
• Premiums paid from Parent to Captive are not deductible.
Subs
• Subs generally shift risk to captive.
•Premiums paid from Subs to Captive are generally deductible provided
certain bona fides are satisfied (e.g., premiums are arm’s length, the Captive
is adequately capitalized, the Captive is not “propped up”, etc).
Captive
• Generally treated as an insurance company.
What is insurance for U.S. tax purposes?
3rd Party Risks
Third-party Risk
Premiums
Parent
Premiums
Subs
Subs
Parent
Captive
Premiums
•
Parent generally shifts its risk to Captive, provided sufficient third-party risk is present.
• Third-party risk benchmark in industry is > 30% of total premium
•
Premiums paid from Parent to Captive are generally deductible (bona fides are
satisfied).
Subs
•
Subs generally shift risk to Captive.
•
Premiums paid from Subs to Captive generally deductible (bona fides are satisfied).
Captive
•
Generally treated as an insurance company.
Who is responsible for tax?
Entity-level taxation
• Double taxation on profits of captive (i.e., taxed at captive and
again at ultimate owner)
• Entity subject to tax by activities
– Engaged in a trade or business in a taxable jurisdiction
– Permanent Establishment Standard may define level of
activities
– Offshore meetings, day-to-day business, etc.
– ASC 740-10 (“FIN 48”) consideration
• Entity subject to tax by election
– Must conduct an “insurance” business
• IRC §953(d) Election
• IRC §953(c)(3)(C) Election – related person insurance
income only
Who is responsible for tax?
Shareholder-level taxation
• Single level of taxation on profits of captive (ie, only at
shareholder)
• Controlled foreign corporation (“CFC”) rules
• Related Person Insurance Income (“RPII”) CFC rules
• Passive Foreign Investment Company (“PFIC”) rules
– N/A if an ‘active’ insurance business
• Disregarded entity election
– Captive cannot conduct insurance business given ‘per se’
status
Who is responsible for tax?
“Inadvertent” entity level taxation
• May have an impact on “healthcare” captives/non-electing captives
• Tax imposed on foreign corporations which ‘engage’ in a ‘trade or
business’ (“ETB”) or have a Permanent Establishment (“PE”)
– Usually inadvertent for a Bermuda captive
– May result in a tax accrual
– ASC 740-10 (“FIN 48”): Company’s potential to have an ETB or
PE?
• Engaged in a U.S. trade or business – not defined
– Judicially defined concept
– ‘regular, continuous, substantial’
– PE standard – applicable only to ‘treaty’ countries; as such,
U.S.-Bermuda treaty would need to apply
– Effectively connected income
• IRC §864(b) Exception (Securities trading income)
Who is responsible for tax?
“Inadvertent” entity-level taxation (continued)
• Branch Profits Tax
– U.S. ETB or PE subject to Branch Profits Tax – 30% or lower if
treaty exists
– Net liability = 54.5%
• Consider the creation of Tax Operating Guidelines to mitigate risk.
U.S. tax elections
IRC §953(d) Election (“d – Company”)
• Election to be treated as a US domestic insurance company
– taxed on worldwide income
• Requirements of the ‘d’ election
– Must be ‘insurance’ company for U.S. Federal income tax
purposes
• >50% of business is issuance of (re)insurance or annuity
contracts
– 25% or more shares owned by U.S. Persons (direct/indirect)
– Revenue Procedure 2003-47
• Provides guidance/steps for making the election
• Election irrevocable without consent
• Cannot re-elect for five years
U.S. tax elections
IRC §953(d) Election – Advantages
• Exemption from the US federal excise tax on premiums paid to a
foreign insurance company
• Exemption from the withholding tax imposed on certain types of fixed
and periodic (“FDAP”) income from US sources
• Exemption from the “branch profits tax” imposed on certain earnings
of foreign corporations that are engaged in a US trade or business
• Ability to hold meetings and conduct business activities within the US
(does not alleviate state regulatory concerns)
• Ability to join in filing a consolidated US federal income tax return (if
applicable)
• Ability to more freely invest in US property
• Ability of US shareholders to enjoy the benefit of the dividendsreceived deduction (“DRD”)
U.S. tax elections
IRC §953(d) Election – Disadvantages
•
Potential for double taxation on distributions made to shareholders
•
Mandatory change of the company’s tax year end to December 31 or
the year end of the parent company in consolidation (if applicable)
Subject to current taxation on worldwide income with no treaty
benefits available
•
•
Subject to Dual Consolidated Loss Rules
U.S. tax elections
IRC §953(d) Election – Filing requirements
• 953(d) Election
– Filed by “extended due date” of tax return
– Calendar year required (unless a member of a consolidated
return)
– US office and assets test
• LoC
• Captive has US assets
• Consolidated return
• Annual filings:
–
–
–
–
Form 1120-PC or 1120-L
Form 990 for certain “tax exempt” insurance companies
Form TD F 90-22.1 if own foreign bank accounts
Estimated Tax Payments - quarterly
Shareholder-level taxation
•
U.S. has no authority to tax foreign corporations not engaged in a U.S. trade
or business
•
Controlled Foreign Corporation or “CFC” Rules (1962)
– Two tier test
• ‘US Shareholder’ defined
– 10% or more voting stock
• ‘US Shareholders’ must collectively own >50% vote or value
• For “Insurance Income” – special >25% Rule replaces standard >50%
Rule
– Deemed distribution provisions
• Insurance income
• Foreign personal holding company income (“FPHCI”)
– Interest, dividends, capital gains, etc.
•
U.S. source premiums subject to Federal Excise Tax (“FET”)
•
Audit/Accounting issues
– Generally no tax accrual at the CFC-level
– ASC 740-10– Determination if a US ETB or PE exists
Shareholder-level taxation
•
Related Person Insurance Income, or “RPII” Rules
– Defined as insuring the US persons who control or is controlled by the
‘insurer’
• Required RPII / Non-RPII split of management accounts
– ‘Any’ shareholder replaces 10% voting shareholder for these
purposes
– 25% or more replaces the >25% ownership test
– De minimis exceptions
• Less than 20% of gross premiums are RPII
• Less than 20% vote /value of the company held by related
persons
•
U.S. source premiums subject to Federal Excise Tax (“FET”)
•
Audit / Accounting issues
• Generally no tax accrual at the RPII CFC level
• ASC 740– Determination if a US trade or business
Shareholder-level taxation
U.S. tax compliance
• Form 5471 - Information Return of U.S. Persons With Respect to
Certain Foreign Corporations
– Category 2 - U.S. officers and/or director filings
– Category 3, 4, and/or 5 – U.S. Shareholder filings
– Filed with U.S. Person’s income tax return
• Form 926 - Return by a U.S. Transferor of Property to a Foreign
Corporation
– Contributions of property by US persons to a foreign corporation
• Form 720 – Quarterly Federal Excise Tax Return
– FET on US risk to certain foreign (re)insurers
Shareholder-level taxation
U.S. tax compliance
• “Protective” Tax Return (optional)
– “protects” company’s rights to deductions, losses, and credits if the
company is found to have an ETB or PE.
• Report of Foreign Bank and Financial Accounts (must be e-filed)
– if a U.S. Shareholder owns more than 50% of the vote or value of
the foreign corporation
– If US officer or director has “signature authority” over foreign
financial accounts of the company
• Form 8938 - Statement of Specified Foreign Financial Assets
– U.S. persons which own certain foreign financial assets
– New in 2011
– Currently only applies to individuals
Healthcare Captives
•
Healthcare organizations are generally considered to be not-for-profit entities;
therefore, they are not typically subject to U.S. Federal income tax.
•
As such, a captive subsidiary of a healthcare organization typically attempts
to operate in a tax-exempt manner:
– Insurance income may be considered unrelated business taxable income
(“UBTI”) to the healthcare organization’s tax-exempt purpose.
• Healthcare organization would currently pay US tax on its UBTI.
– The healthcare captives typically structure their activities in order to NOT
be considered an insurance company for US tax purposes.
• This avoids UBTI and thus tax at the shareholder-level (via CFC
rules).
• The healthcare captive achieves this by insuring a large amount of
parent risk in relation to other insurance risks (Rev Rul 2002-89).
– This would ensure that there is not adequate “brother-sister” or
“third party” risk for risk shifting and risk distribution to occur.
•
U.S. source premiums are not subject to Federal Excise Tax (“FET”) if not
meeting the definition of ‘insurance’ for US tax purposes.
– Reinsurance premiums ceded by captive are subject to FET
U.S. Federal Excise Tax (“FET”)
• IRC §§ 4371- 4373
– 4% on direct premiums
– 1% on life, annuity, health, and reinsurance
– “tax” maybe assessed on both payor and payee
• Assessed on premiums ‘paid’
• Compliance
– Form 720 - filed quarterly
• Cascading theory
U.S. Tax Obligations Summary
*Insured cannot deduct premiums paid
Are the Company’s
contracts insurance?
No
*Potential US tax filings
* “protective” returns
* Form 5471 – if CFC
* PFIC Statement – if PFIC
Ye
s
US taxation:
Entity level vs.
Shareholder level?
d
hol
a r e ve l
h
S Le
er
Filing Requirements:
US Shareholder
* Form 5471 (Cat 5) if CFC - Annual
* Form 926 / 5471 (Cat 3) – on certain contributions
* Form 8938 - Annual
US D&O’s
* Form 5471 (Cat 2) – on certain contributions
Insureds
* Form 720 – US risk to foreign insurer (i.e.,
Captive) – Quarterly
Company
* “protective” return - Annual
En
ti
ty
L
ev
el
Filing Requirements:
Company
* 953(d) Election – One time
* Form 1120-PC – Annual
* Est. Tax Payments – Quarterly
* Form TD F 90-22.1 – Annual – if own foreign financial accounts
* Form 720 – if reinsure US risk to foreign insurer - Quarterly
Income Tax Provision
• Companies that require a Tax Provision Review:
– Offshore insurance companies that have made an IRC§953(d)
election or an IRC§953(c)(3)(C) election
– Offshore company which conducts a US ETB or has a PE
• Requirements will depend upon the form of the financial
statements
• U.S. GAAP
• Bermuda statutory
• IAS
• Other
Tax Information Exchange Agreement
(“TIEA”)
• What is a TIEA?
• Bilateral agreements to provide assistance in tax matters through an
exchange of information to assist 2 countries in administering, enforcing
and collecting their respective taxes
• Bermuda government currently has 23 TIEA’s to date
• Canada-Bermuda TIEA signed on June 14, 2010
• Tax Benefits
• Ability to repatriate earnings on a tax-free basis to a Canadian parent
• Who might benefit?
• Canadian multinational companies with profitable non-Canadian
subsidiaries seeking to self-insure existing risks.
Foreign Account Tax Compliance Act
(“FATCA”) – in brief
• FATCA treats (re)insurance premiums as ‘withholdable payments’;
as such, subject to 30% withholding unless FATCA compliant
• Effective July 1, 2014
• 953(d) Electing Companies
– Treated as U.S. persons and thus U.S. w/h agents
– Annual filings
• Form 1042
• Form 8966
• Bermuda P&C insurance/reinsurance companies (no elections)
• Typically Passive NFFE’s
• Must complete Form W-8BEN-E to avoid w/h
• Disclosure of U.S. owners may be required