BEPS and Brexit driving change in Europe
Rather than a host of new captives formations, we are seeing more changes in existing structures. This may be because of the mature market, meaning that most companies which had a clear rationale for a captive have already set one up; or because of the continuing soft market; or because of legislative pressures which mean captives are having to defend and justify their position or restructure to keep up with a changing landscape for parent companies.
There has been a slowing of new captives formations in Europe, where it is a mature captives market, and with some of the recent legislative changes—particularly in comparison to other captive insurance markets around the world.
We have seen, however, companies considering setting up captives for increasingly unusual or sophisticated transactions, as well as businesses which are responding to the pressures of a hardening insurance market and considering deploying a captive insurance strategy where previously it hadn’t made financial sense. These same forces have been at play with established captives.
The ‘quick wins’ for running a captive have largely been won; at present it is more common for captives owners in Europe to review their strategy and consider what else they can do to use their captives better.
In part, this is down to the potential hardening of the commercial insurance market, so captives owners can consider how they can deploy their captives to work with the insurance market to protect against this, either by taking more risk on existing lines or by including additional lines of business in the captive.
In some instances, a large strategic change in the parent company triggers a similar review of the captive. Companies who have had captives for a long time are considering what exactly are the benefits of their entities. Similarly, where companies are changing and merging quickly, captives need to be consolidated, updated or novated to keep them current for the parent.
One of the largest driving forces in Europe of captives change has been legislative pressure forcing companies to reconsider why they have a captive, and this has led to domicile reviews, either for the associated risk of having an offshore entity or for passporting requirements.
The two ‘B’s have dominated European captives discussions in the past 12 months: the OECD’s base erosion & profit shifting (BEPS) actions and Brexit. These are dominating strategic discussions, and more particularly triggering longstanding captives to reconsider domicile location, structure, or whether it is worthwhile at all.
The recent update from the OECD on transfer pricing in captives demonstrated an increased appreciation for the value created by captives for their parent companies (see the author’s previous BEPS article).
However, the onus rests on captives owners to demonstrate the rationale of the rates set, and of the reasoning behind setting up a captive. There is still a gap in the perception of ‘uninsurable risk’ and the validity (and crucial role) of these transactions, as well as the onerous legislation to which captives adhere.
While there is more work to be done to develop the idea in relation to captives, owners are preparing to demonstrate the value and rationale for their creation as a true risk mitigation and management tool.
The outstanding question of what the UK’s departure from the EU will mean for companies in Europe means captives owners are having to prepare for a range of outcomes. Notwithstanding the business risks, the key concern over Brexit for captives owners is passporting.
The UK’s Brexit paper from the summer has specified the government’s plan to move out of the single market, with an aim to negotiate a separate policy for the UK.
For EU captives writing UK risks, this will mean either arranging a fronting carrier with a UK-based insurer (they will issue the policy, and then reinsure it to the captive), or ceasing to write the UK lines of business. Captives owners will have to work with their managers to decide which is the best option for their captives, and for the parent businesses.
The certainty of Guernsey, which sits outside the EU, may explain why most captives setups in Europe have been there.
Captives owners can consider their options. Even if this is only to have a contingency plan in place, it is an interesting time for reviewing whether the captive is still serving the right purpose, if it could do more, and if its structure and location are still right for the business.
Although these discussions incur time and cost in some places, reviewing the captive’s use in line with external pressures is the only way to ensure it is still operating most efficiently.
Alexandra Gedge is a business development and captives executive at JLT Insurance Management. She can be contacted at: firstname.lastname@example.org