Asian captive domiciles positioned for growth
Asia is a huge growth market for captive insurance. The number of captives in Asia and premium volumes are expected to grow rapidly, because of the hard insurance market and because the world’s economic growth is pivoting toward Asia.
Which of the existing top captive insurance domiciles in the region—Singapore, Labuan or newcomer Hong Kong—will be the winner? Will the answer depend on tax rates, regulatory regimes, geographical location or other factors? And how will this all fit into a wider corporate group’s regional ambitions in Asia-Pacific?
This article discusses the current status and features of these three captive domiciles and how each of them positions itself to capture the expected growth, each in their own unique way.
Captive insurance in Asia
Asia currently accounts for only 3 percent of captives globally, with 168 of the total 6,315 domiciled in Asian jurisdictions, according to the Monetary Authority of Singapore (MAS). Asia, however, has seen a significant growth in recent years, increasing by 30 percent from 129 in 2015 to 168 in 2018.
Singapore and Labuan lead the number of captives in the Asian region. At the time of writing, Singapore is home to 78 captives while Labuan has 56. Hong Kong, a relatively recent market entrant, has only four captives.
Global commercial insurance premiums have been rising for three consecutive years and this trend is not expected to reverse any time soon, with COVID-19 claims and the economic recovery, fuelled by expansive monetary policies, driving demand.
“Singapore’s overall value proposition as a captive insurance domicile remains sound and will be strengthened in the long run.”
Risk managers of large-and-mid-size multinationals may have previously shied away from captives because of the increasing regulatory and fiscal compliance burden. The Organization for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project and the upcoming IFRS 17 implementation, exemplify this problem.
Now, however, businesses are taking a fresh look at captive insurance structures because of their value in proactively managing the group’s risks and the difficulty obtaining coverage in the open market for their changing risk profiles. As industries digitise, multinationals typically hold significantly more intangible assets than tangible ones. For some of these bespoke risks, a captive and direct access to the reinsurance market may be the only solution.
As the risk profile of global groups shifts towards Asia, and as more Asian conglomerates expand globally, existing and up-and-coming Asian jurisdictions are revisiting their captive insurance regimes to capture the expected growth. At the same time, revisions are being considered to their tax regimes, to conform to OECD requirements, specifically concerning minimum substance under BEPS.
Singapore is the established Asian captives market leader. The country’s political stability, highly skilled and multilingual work force, trusted legal system and stable currency, all provide an attractive environment for long-term risk management.
It is Asia’s non-life re/insurance centre, offering a developed service industry and direct access to the reinsurance market, making it a natural fit for captives seeking to manage large and complex risks.
A key driver for this is Singapore’s regulator, the MAS, which is well respected by regulators in insurance hubs around the world. It pursues an active policy to strengthen and develop Singapore as an Asian re/insurance centre, including attracting captive insurance solutions.
A large proportion of groups currently owning Singapore captives are from Australia. Singapore is relatively close, while many Australian groups have a regional head office or treasury function in Singapore, which has made it a logical choice. Recently, interest from Japanese groups has increased as well.
Singapore has always sought to offer attractive tax incentives to captives. Periodically these are updated, most recently this May. In the Singapore Budget 2020 statement, it was announced that the Insurance Business Development–Captive Insurance (IBD–CI) scheme would be extended until December 31, 2025.
Under the current IBD–CI scheme, approved captives are granted a concessionary tax rate of 10 percent for five years on qualifying underwriting and investment income. The scheme is available for direct insurance and reinsurance, and applies to onshore and offshore risks.
Certain classes of risk which are considered commoditised (direct standalone fire, motor, work injury compensation, personal accident and health insurance policies) do not qualify for the incentive.
While the above scope of qualifying income and benefits under the IBD–CI scheme has not changed significantly since the revisions announced in 2017 (abolishing the limitation of the incentive scheme to offshore risks), additional conditions have been introduced for both new and renewal IBD–CI applications in a May 2020 MAS circular.
IBD–CI applicants are required to have a minimum of two professionals who are engaged substantially in the qualifying activity. To qualify, the professionals must have a minimum diploma or equivalent qualification. The introduction of this qualitative and quantitative substance requirement was necessary to meet the evolving OECD BEPS minimum standards.
It was also announced in 2019 that captives whose incentive awards were approved before June 1, 2017 and expire after June 30, 2021 will continue to enjoy the benefits under their existing awards, such as tax exemption for offshore risks. However, for BEPS compliance reasons, these captives will become subject to the above-mentioned scope of qualifying income (which would apply equally to new IBD–CI applicants) as of July 1, 2021.
Singapore’s overall value proposition as a captive insurance domicile remains sound and will be strengthened in the long run. Geopolitical tensions, especially the US-China trade disagreement, will make many owners look for long-term stability in Singapore. The tax concession remains attractive and demonstrates the government’s commitment to adopt practices which are aligned with OECD’s BEPS action plans.
Those captives which currently do not have the economies of scale to support the required headcount will rethink their options, either by increasing their premium volume through adding new lines of business and increasing their retentions, or by enjoying the still favourable general tax rate of 17 percent. It should be noted that 17 percent is higher than the expected threshold for the application of the BEPS 2.0 minimum tax rate, so it should remain beneficial even after the eventual adoption of the new OECD measures.
Labuan was established in 1990 as an international offshore financial centre and grew to be one of the few preferred offshore financial centres in Asia. Its political stability, strong economic foundation, competitive and favourable tax regime and attractive regulatory framework for both conventional and Islamic captive insurance all add to its appeal.
Labuan is the only Asian captive domicile offering protected cell companies (PCCs). PCCs allow a sharing of captive common costs among the cell owners, making them cost-effective. It is therefore no surprise to see Labuan being recognised as one of the preferred and fastest growing risk management centres in Asia.
Like Singapore, and consistent with global changes introduced by OECD’s BEPS action plans, Malaysia is committed to addressing tax evasion and harmful tax practices, including the elevation of substance requirements in Labuan. Labuan captives must now have at least three full-time employees and a minimum of RM200,000 (about $47,500) annual operating expenditure in Labuan to qualify for the preferential tax rate of 3 percent of net audited accounting profits. This came into effect from 2019.
Initially, these changes took the Labuan market by surprise but the network of 50+ captive insurers welcomed such initiatives to endorse international best practices recommended by OECD. BEPS-compliant standards of regulation (qualitative and quantitative) together with a matured environment provide confidence to the regulators to continuing promoting Labuan as a well-established captive insurance domicile.
Additionally, there is an emerging market position that the substance requirement can be met in mainland Malaysia rather than in Labuan itself, making it a more practical option for multinationals with existing substance in Kuala Lumpur. The fact that labour costs in Labuan and mainland Malaysia are significantly below those in Singapore and Hong Kong helps to mitigate the additional cost of complying with the new substance requirements.
Hong Kong’s existing captive insurance market is small compared with those of the established Asian domiciles. Since 2012, Mainland China has encouraged Chinese companies to establish captives in Hong Kong, although with limited success. As of July 31, 2020, there are four Hong Kong captives, all owned by Mainland Chinese state-owned enterprises (SOEs).
They are used primarily to insure the risks of their Hong Kong group entities, as well as some Mainland China risks. It enjoys a regulatory advantage in this, as Hong Kong reinsurers have equivalence with Mainland reinsurers for Chinese regulatory credit risk charge purposes.
In light of China’s national policy initiatives, such as the Greater Bay Area initiative and the broader Belt and Road Initiative, Hong Kong has a larger role to play as a risk management hub and captive location. Accordingly, its government started to promote the insurance sector in recent years.
Under the Insurance (Amendment) Bill 2020, passed in late July, Hong Kong captives are now permitted to write overseas group business, not just Hong Kong domestic business. The previous limitation of being able to insure only Hong Kong incorporated and registered companies severely limited the usefulness of Hong Kong captives for multinational groups.
Hong Kong has also updated its tax concession for local authorised captive insurers by dropping the limitation of the 50 percent reduction in the corporate income tax rate in Hong Kong to offshore risks. Commencing from the year of assessment 2018/19, such tax concession is extended to onshore risks. In other words, captive insurers in Hong Kong can now enjoy an effective profits tax rate of 8.25 percent on their insurance business of both offshore and onshore risks.
There is no time limit on the concessions. As a result, unless there is a change of the fundamental domestic tax legislation in Hong Kong, captive insurers are eligible for the tax concession indefinitely on the basis that the relevant requirements are met. There are also threshold requirements for the level of activities in Hong Kong, for example the number of employees with sufficient qualifications and the amount of operating expenditure incurred in Hong Kong, to qualify for the tax concession.
That is in line with BEPS requirements, but the details of the threshold requirements for this concession are yet to be released by the Hong Kong tax authority.
Looking into the future, all three jurisdictions now have tax incentive schemes compliant with BEPS substance requirements and are looking to seize additional market share. Each domicile has its own target segment: Singapore is the location of choice for Australian multinationals and increasingly attracts Japanese and non-Asian groups with diversified Asian investments; Hong Kong targets the Chinese market; and Labuan has its existing niche.
We would expect tax to play a less important role over time as a factor to distinguish between captive insurance jurisdictions. The current BEPS 2.0. initiative is expected to establish global minimum tax rules under its Pillar Two, effectively negating any tax benefit beyond a certain point.
Singapore and Hong Kong both have attractive regular tax rates, even without the incentive schemes, and the main attractiveness of their captive regime, as it should, comes from non-tax factors.
With that, the 2020s may well become the decade of the Asian captive.
Adrian Halter is a tax partner in the financial services organisation at EY in Singapore. He can be contacted at: firstname.lastname@example.org
Bernard Yap is a tax partner at EY in Malaysia. He can be contacted at: email@example.com
Ji Yao is director of actuarial and insurance, business consulting at EY. He can be contacted at: firstname.lastname@example.org
Ming Lam is director of financial services tax at EY Tax Services in Hong Kong. He can be contacted at: email@example.com
Shen Mei Soh is manager of financial services tax at EY. She can be contacted at: firstname.lastname@example.org