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Solvency II, Brexit and OECD BEPS are some of the influential forces reshaping the captives domicile landscape in Europe, and many captive owners are looking at the growing attractiveness of onshore vs offshore, explains Ciaran Healy of Willis Towers Watson.
Statistics suggest that the captive insurance landscape in Europe is stable and in slight decline. The majority of domiciles have maintained relatively steady captives numbers over the last five years with most locations experiencing slightly higher rates of licence surrender than new formations.
However, this simplistic assessment belies a complex and dynamic landscape, which is characterised by an ecosystem of mature domiciles, sophisticated captive owners and a range of volatile external factors, which combine to create a highly energised environment.
Forces of change
In physics, an object will remain stable unless enough energy is introduced to system for the constituent molecules to become energised enough to break the stabilising bonds, resulting in a change of state, eg, the melting of a solid into a liquid.
This is an apt metaphor for the European captives landscape, which although currently stable, is experiencing the introduction of significant amounts of energising forces, which have the potential to see a captive break its bond with the current location and result in a very different landscape in the near future.
The balance within the European captives landscape is currently being influenced by three key factors in particular:
- Solvency II;
- Brexit; and
- Base erosion and profit-shifting (BEPS).
The European captive insurance industry has experienced significant regulatory change in recent years with the introduction of Solvency II. In the majority of cases, captives in affected domiciles have adapted without disrupting the balance within the European captives eco system. However, Solvency II has raised the entry point threshold which, together with the prevailing ‘soft’ insurance market, has reduced the rate of new formations.
The two ‘offshore’ domiciles in Europe, Guernsey and the Isle of Man, both falling outside Solvency II requirements and maintaining significantly lower points of entry for captives, have thus become the preferred location for smaller and mid-market captives.
Another phenomenon observable as a consequence of Solvency II is that captives in the less traditional domiciles, (typically characterised has having a small population of larger, self-managed captives) are struggling with the stance of local regulators. In such locations, regulators tend to have less familiarity with the captives business model and can treat captives in a manner similar to a commercial insurer. This is compounded by the absence of local captives expertise and service providers, which can result in a significant amount of management time being required to run the captive.
A number of captive owners in France, the Nordics, the Netherlands and Germany have begun investigating whether relocation to a more recognised captives domicile with greater outsourcing options would be a solution to this issue.
The UK’s decision to exit the EU may have far-reaching implications for the entire insurance industry and captives are no exception. It is not yet possible to predict with any certainty what the post Brexit landscape will look like as negotiations between the EU and the UK at a political level continue to stagnate.
Current thinking in the industry is that, post Brexit, captives located within the EU will no longer have the ability to access the UK directly. Given that the majority of captives based in EU domiciles have some level of UK-based risk, Brexit will require captive owners to invoke some degree of change to current arrangements. For the majority, the obvious solution is to use a fronting partner to issue policies in the UK, ceding the risk to the EU-based captive. This change will inevitably increase frictional costs through the introduction of fronting fees and security requirements associated with this arrangement.
However, for EU captives where the majority of premiums are related to UK-based risk, this approach may prompt a review of the appropriateness of the current domicile, which may become significantly less economical post Brexit. To further compound the potential negative outlook for EU captives with significant levels of UK risk, there may be other unintended consequences arising from the post Brexit scenario.
For example, the Central Bank of Ireland has traditionally held the stance that a captive with an insurance licence should maintain the majority of premiums from directly written business and not ‘inwards reinsurance’ or fronted business. In cases where the long-term outlook was for a predominance of fronted premium, there was an expectation that the captive would convert to a reinsurer, thus requiring all business to be fronted.
Should this stance be maintained, there is a risk that a number of Dublin-based captives with a majority of UK-based business would need to go through a costly licence conversion process and lose the ability to access any location directly. This would almost certainly prompt captive owners to reconsider their domicile decision and probably lead to a number of redomiciliations.
There have also been a number of captives relocations even before the emergence of the final Brexit position, with a ‘swapping’ of captives between Gibraltar and Malta. Gibraltar, being a UK territory, expects to leave the EU as part of Brexit, losing its ability to ‘passport’ into EU locations but maintaining its ability to issue policies to the UK.
A number of entities in Malta, originally set up to cover UK risks, are now in the process of relocating to Gibraltar, with the move in the opposite direction for entities established in Gibraltar whose business is sourced from EU locations.
For the majority of captive owners in EU locations, Brexit remains an uncertain variable and although contingency plans are in place, most are adopting a holding position until more certainty emerges.
BEPS is arguably the most influential force in European captives domain at the moment. This global tax reform is bequeathing tax authorities with increased new powers and interrogating the legitimacy of captives worldwide.
The country-by-country reporting requirement of BEPS, which requires multinationals to disclose key financial information relating to each location where they have a subsidiary, can be seen to potentially expose captives in domiciles where the parent would not otherwise have a presence.
This, together with scandals such as the ‘Paradise Papers’, has heightened multinationals’ sensitivity to reputational risks associated with being located in perceived ‘tax havens’.
This is generating two emerging trends:
- A move from offshore to onshore: A number of captive owners have relocated their captives from offshore locations with zero corporate tax rates to onshore locations to reduce the reputational risk associated with the captive, albeit accepting higher annual costs and capital requirements as a result.
- Investigation into the potential to relocate the captive to the parent company location: A number of captive owners are currently investigating the viability of establishing the captive in the parent company location. In most cases, these locations have little or no captives infrastructure and regulators less familiar with the captives business model than the recognised captives domiciles, which can create challenges as referenced previously. This trend is diametrically opposed to the zeitgeist of captives in locations such as Germany, France and the Netherlands who are struggling with the application of Solvency II in these locations.
Similar to Brexit, BEPS has created a considerable amount of discourse in European captives circles, with some organisations committing to a change of location from the outset. However, the overriding position of the majority of captive owners is one of consolidation and further investigation. Although a potentially incendiary topic, a large proportion of captive owners remain undecided with regard to their ultimate position regarding BEPS, despite acknowledging the need to address this point in the short term.
With the significant levels of uncertainty present in the European captives landscape and the position of the recognised captives domiciles shifting relative to the new and emerging factors, together with the potential for more captives to be established in alternative locations to the traditional domiciles, the situation is extremely fluid.
However, with most captive owners understandably adopting a ‘wait and see’ position on issues such as Brexit and BEPS, the status quo will remain for the short term.
The intriguing ‘push/pull’ dynamic (the push due to the perceived more onerous application of Solvency II, and the pull due to BEPS) regarding establishing captives in the location of the parent location is likely to continue until the position of European tax authorities on BEPS becomes more apparent. The stance taken by tax authorities will undoubtedly also influence the ‘offshore to onshore’ trend and as we approach the deadline for the UK to exit the EU, Brexit outcomes will inevitably become more certain and captive owners’ Brexit scenarios become clearer.
The combination of these imminent developments could potentially reshape the European captives landscape to an unprecedented extent. We will have to wait and see just how impactful these factors will turn out to be, but it should be an interesting 18 months.
Ciarán Healy is captive consulting & development lead, EMEA, at Willis Towers Watson. He can be contacted at: firstname.lastname@example.org
Captives, Solvency II, Brexit, Europe