A new breed of captives

30-07-2018

Owen Faulkner

A new breed of captives

Greg Panosian / istockphoto.com. Pictured: Sandy Bigglestone

US tax reform provisions have created a substantial tax burden for US insurers conducting business in offshore jurisdictions. Vermont has stepped in with new captive legislation that aims to provide a more favourable onshore alternative, Sandy Bigglestone, director of captive insurance, Vermont Department of Financial Regulation, tells Captive International.

Vermont is no stranger to streamlining its captive laws and regulations, and exploring new alternative risk transfer structures. In May 2017, Vermont had introduced legislation allowing for the licensing of agency captives, which in turn was a big topic of discussion at that year’s Vermont Captive Insurance Association’s annual conference.

In May of this year, Vermont’s governor Phil Scott signed into law new legislation allowing the licensing of a new type of captive: affiliated reinsurance companies (ARCs).

The law is aimed at creating a more favourable reinsurance alternative for US companies conducting business in offshore jurisdictions that are now faced with a substantial tax burden from Base Erosion Anti-Abuse Tax (BEAT) provisions included in the Trump administration’s tax reforms.

Sandy Bigglestone, director of captive insurance, Vermont Department of Financial Regulation, says the ARC structure provides one of several alternatives to US insurance companies seeking to avoid the tax burden of the BEAT on reinsurance ceded to non-US affiliates.

With the ARC law in place with a reasonable set of standards to employ, Bigglestone says that Vermont is positioned to begin accepting applications for licensing immediately. While she doesn’t anticipate a growing trend of a large volume of formations, she says that Vermont has a few leads for this new option.

“Vermont’s experience and reputation for quality regulation should offer some attraction for companies needing a more favourable domestic alternative to offshore reinsurance affiliates,” says Bigglestone.

Background

On December 22, 2017, the US Tax Reform Act was enacted, which defined premiums ceded by US insurance companies to foreign affiliates as base erosion payments.

Companies with large US operations are now subject to the BEAT, which significantly increases the expense of using reinsurance vehicles outside the US.

“The ARC structure recognises the benefits of a traditional reinsurance company while providing flexibility of captive insurance regulation.”

The BEAT applies to US insurance companies that have average annual gross receipts of at least $500 million and a base erosion percentage of 3 percent or higher. It establishes a minimum tax rate of 5 percent in 2018; 10 percent in 2019 and 12.5 percent after 2025.

Bigglestone notes that certain insurance companies that have made the 953(d) election under the US tax code—where an insurance subsidiary is treated as a domestic corporation for US tax purposes—will not be allowed to offset any net operating losses.

It should also be noted that the BEAT applies only to payments to foreign affiliates and therefore third-party reinsurance would not be implicated.

As well as the increased liability from BEAT, insurance companies are also still subject to an excise tax rate of 1 percent or 4 percent on re/insurance premiums paid to foreign insurers and reinsurers with respect to risks located in the US.

Fitch Ratings’ Bermuda 2018 Market Update had suggested the combination of the cut in the US corporate tax to 21 percent (from 35 percent) along with the BEAT will “significantly reduce the long-standing tax advantage of Bermudian re/insurers over those in the US”.

Impact

Bigglestone says that that insurance companies have been evaluating the expected impact on their offshore affiliated reinsurance activities, and she encourage insurers to review their foreign affiliated reinsurance arrangements with tax professionals to better understand the BEAT and its applicability.

“In cases involving large insurance companies with significant reinsurance payments to foreign affiliates, in the absence of implementing any proactive measures, tax reform could cost tens of millions of dollars in 2018 and grow to hundreds of millions of dollars in 2019,” she explains.

Bigglestone suggests that US insurance companies are concerned about maintaining their affiliated reinsurance arrangements, which provide operational control and consistency, effective capital management, continuity of reinsurance availability, and lessen the volatility of reinsurance market fluctuations.

“Effective January 1, 2018, to avoid the implications of the BEAT, reinsurance transactions between US companies and their offshore affiliates, in some cases, were terminated and recaptured or commuted, which will likely result in significant capitalisation changes (increases to meet risk-based capital requirements) and could have potential effects on the pricing of products,” she says.

For these reasons, Bigglestone, along with Vermont’s deputy commissioner of captive insurance David Provost, said the timing of this legislation was crucial, and helps Vermont to establish itself as a US alternative to affected insurance companies.

“Vermont wanted to be a part of the solution to retain US underwriting profits in the US consistent with the spirit of the act by allowing US insurance companies to cede to a US affiliate instead of a foreign affiliate,” says Bigglestone.

How do they work?

The ARC structure has been described by Provost as “akin to a hybrid between captives and traditional insurance”.

Vermont is the first state to provide this type of solution, and it is a new type of captive that will be permitted to reinsure the risks of a ceding insurer that is its parent or an affiliate of the parent (pursuant to an approved plan of operation). The structure will also be permitted to retrocede the risks assumed by the ARC.

ARCs will be subject to many of the laws and regulations under National Association of Insurance Commissioners (NAIC) accreditation standards but will be licensed and regulated by the Vermont Captive Insurance Division.

A key feature of the ARC law is a simplified investment statute, explains Bigglestone.

“Traditional insurers and reinsurers in the US are typically faced with very prescriptive and outdated investment regulations,” she says.

“The ARC law requires companies to file an investment plan for regulatory approval. The plan must address diversity in type and issuer of investment and provide for sufficient liquidity for solvent operations consistent with NAIC accreditation requirements.”

She continues: “The Vermont Captive Insurance Division has had many years of experience with other types of captives implementing a blend of traditional and captive insurance regulation. The ARC structure recognises the benefits of a traditional reinsurance company while providing flexibility of captive insurance regulation.

“The new legislation in Vermont will bring affiliated reinsurance business onshore, enabling US insurance companies to achieve the same purpose under a similar set of rules, and the onshoring of such affiliated transactions will assist in the regulatory oversight of the insurance group under the mission of the NAIC accreditation programme.”

US Tax Reform, Vermont Department of Financial Regulation, Sandy Bigglestone, Captive insurance, Reinsurance, Affiliated reinsurance companies, Vermont

Captive International