Captives provide a means for insurance companies to extend their exposure with fewer regulatory restrictions and greater tax advantages
Many UK insurance intermediaries have set up captives in domiciles such as Gibraltar and Dublin, as they present a cost effective solution to covering some of their exposures.
The theory is that an offshore captive enables the entire underwriting process to be in-house, by eliminating the margins of the third-party fronting company and broker commissions. Captives can also write specific policies that avoid overhead costs and the profit element inherent in the terms quoted by a conventional insurance company.
Clearly, the use of direct-writing captives presents a effective alternative to corporate clients, providing direct access to the reinsurance market, where risks may generally be underwritten on more favourable terms than the primary insurance market.
Gibraltar and Dublin are attractive options in that insurers established in these domiciles may underwrite any business classified as "large risks" across borders within the European Economic Area (EEA), without the need to establish subsidiaries or reserves in other EEA member states where the company intends to conduct business.
Both Ireland and Gibraltar have full EU membership which allows "offshore" domiciled insurance companies to provide insurance cover without "fronting" insurers.
From a UK tax point of view many companies seeking to establish a captive insurer in an offshore domicile usually take into account only the solvency margin aspect and simply proceed by engaging a local insurance management company to lodge the licence application with the regulatory authority by preparing the necessary business plan.
The minimum capital requirement within the EU is between EUR2m and EUR3m depending on the type of risk being written.
Each domicile establishes its own solvency margin (capital divided by premium) that must be met. In the EU the solvency margin is regulated for direct insurers. Generally a new insurer is required to have a minimum solvency of around 18% of net premium on the first EUR50m, taking into account reinsurance.
In jurisdictions like Gibraltar it has also been common to use the concept of "protected cells" to reduce overheads by using a insurance manager, who provides the necessary administrative support for policy issuance within the framework of one limited liability company which has several cells.
It is surprising, however, that many companies establishing a captive insurer or a direct insurance presence do not consider any tax implications to take advantage of the EEA passporting Directives and cost effective solvency margins.
Insurance companies in Gibraltar can be tax exempt. It is, however, envisaged that a corporation tax rate of 8% on operating underwriting profits will be imposed. In Dublin the present tax rate for licences issued after 31 December 2002 is 12.5%.
If the offshore captive or direct insurer is properly structured, it can avoid the need to have the UK parent or affiliated company deemed a "branch office" or a representative office.
Each application for an insurance licence has elements that need careful consideration when it comes to the taxation of the profits made in the offshore domicile. Simply having a tax exempt status by paying a nominal fee to a regulatory authority in an offshore domicile is not going to satisfy the "control test" of the Inland Revenue.
Furthermore, it is possible to have arrangements that would allow other advantages such as employee benefit schemes which would enable significant tax savings both in the UK and in the offshore domicile.
Another key benefit of structuring the offshore insurance company is the ability to attract bank finance for increased capitalisation. There are at present innovative corporate structures that satisfy the Regulatory Authorities and still provide the necessary capitalisation to satisfy the amount of underwriting capability.
The concept of 'protected cells' must be carefully considered as there are direct implications with regard to EU Directives on the insolvency of one cell and the impact of that on the assets of another cell.The key here is to first plan a tax strategy to ensure that there are no hidden surprises that will eat into the cost savings. It is better to spend a little more time on the plan before taking the plunge and having regrets later.
