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12 January 2018Analysis

Puerto Rico: an emerging captive domicile

Puerto Rico has been generating some headlines recently with news of its impending bankruptcy and the devastating effects of Hurricane Maria. But, behind the scenes, there is some good news, as Puerto Rico works on its strategy to become the ‘Singapore of the West’. Our company has experience working in many domiciles, both US-based and foreign. We established a presence in Puerto Rico in 2015 under the International Insurance structure, and have seen rapid growth since then.

Puerto Rico has been a territory of the US since 1898, when it was acquired from Spain after the Spanish-American War. With approximately 3.5 million residents, Puerto Rico is the most highly populated of all US territories. People born in Puerto Rico are US citizens.

Hurricanes Irma and Maria caused tremendous damage, although the business and tourist sectors have sprung back rapidly. A silver lining in this destruction might be the ability to rebuild infrastructure in a more sustainable way. Very encouraging reports of Tesla solar minigrids, and Google internet coverage show the potential for building a model island future based on green energy and other developing technologies.

“A section of the tax code similar to 831(b) exempts the first $1.25 million of net income from taxation; income above that amount is taxed at only 4 percent.”

As a captive domicile, Puerto Rico offers several advantages, some of them unique. The bilingual culture makes it an attractive domicile to many parts of Latin America, particularly businesses which also have US operations. This makes Puerto Rico an ideal bridge between Latin America and the US. The domicile is also a regulated and accredited member of the National Association of Insurance Commissioners (NAIC), and the US Federal Reserve, and in some cases the Federal Deposit Insurance Corporation (FDIC), protect Puerto Rican banks.

Puerto Rico’s territorial self-governance with the US creates a “dual sovereignty” where some matters are governed by US law while Puerto Rico law takes precedence in others, such as corporate and insurance laws. In particular, there is a separate and distinct Puerto Rico Internal Revenue Service. A section of the tax code similar to 831(b) exempts the first $1.25 million of net income from taxation; income above that amount is taxed at only 4 percent. This tax regime also applies to larger captives making Puerto Rico attractive to many captive owners of all sizes.

A captive domicile seeking not only to grow, but to thrive over the long run, must also offer the right balance of regulatory oversight and appropriate incentives to encourage growth. For captive domiciles, these incentives take many forms, including reduced taxes and fees, responsive application review processes, and regulatory oversight of capitalisation and loss reserves that are appropriate for the nature of the coverages in the captive insurance company.

Puerto Rico is already a well-established domicile with more than 150 captive insurance companies. It is also the third largest insurance domicile in all of Latin America. Its annual premiums in excess of $11 billion annually trail only Mexico and Brazil. This existing regulatory infrastructure suggests Puerto Rico has the capacity and experience to manage a growing captive insurance sector.

Perhaps the most encouraging sign for the domicile is the number of captive managers making significant investments of time and personnel in Puerto Rico. USA Risk Group has made its presence felt with Spencer Re, the first international reinsurance company formed in Puerto Rico. Similarly, Captive Alternatives has formed both Madison International Insurance Company and Madison Re, II, to spearhead its operations in Puerto Rico. Other organisations such as Ryan Tax are also increasing their presence in Puerto Rico.

US-domiciled captives face uncertainty from a number of sources. These include unresolved issues related to the PATH Act and its changes to 831(b), ongoing activity in the US Tax Court targeting 831(b) captives, evolving definitions of risk distribution and pooled reinsurance, to name a few. With the level of legislative, judicial and regulatory uncertainty captives are currently facing in the US, many find Puerto Rico an increasingly attractive option.