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22 February 2018Accounting & tax analysis

US tax reforms not expected to slow take-up in captives

Discussions around US tax reform and the implications this may have on captives can distract prospective owners from the primary business reasons behind setting up a captive in the first place.

This is according to Elizabeth Steinman, managing director at Aon Risk Finance & Captive Consulting, who does not expect tax reform to have a significant impact on the growth of captives.

“Taxes should not be the primary driver of forming a captive insurance company. Tax is certainly taken into consideration, and with the new tax rates, there is less of a tax benefit in forming a captive than there was at the higher rate if the captive qualifies as an insurance company for tax purposes,” she says.

The tax cuts have been considered the most dramatic tax change for corporations in decades, with corporate tax rates dropping significantly in 2018.

Under the Tax Cuts and Jobs Act of 2017, C corporations—which includes many insurers and captive insurers—will see their US federal tax rate cut from a top rate of 35 percent to 21 percent.

“Captives are formed for many different financial and risk management reasons. Companies often use them as a strategic risk management tool, and it can help facilitate a more global approach to risk management. They can provide greater control of pricing, control of premiums, and control over their insurance programmes,” says Steinman.

This is supported by Aon’s Global Risk Management Survey 2017, in which 37 percent of companies surveyed said that their reason for having a captive was for its use as a strategic risk management tool, followed by 13 percent for cost efficiencies, 15 percent for the control of insurance programmes, 10 percent for the reduction of insurance premiums, 5 percent for risk finance expense optimisation, and another 5 percent for access to the reinsurance market.

Only 6 percent of respondents cited tax optimisation as their reason for having a captive.

As to whether the US tax reform makes the industry more or less attractive, Steinman says the captives industry has been growing consistently each year, regardless of the market and any other factors.

“The act is going to have companies and advisors focusing on different or additional areas potentially, but I don’t think it will slow the growth of the sector,” she says.

Seeking advice

Following the introduction of this legislation, Steinman believes it is important that existing captive owners take a look at their current captive structure—whether onshore or offshore—to ensure that it is optimally structured and that they understand the tax changes and any effect they may have on the captive.

Steinman says that captive owners should be consulting their independent tax counsel along with their captive manager to review their captive’s structure.

US captives taking a tax position that are currently being treated as an insurance company for US federal tax purposes should review their structure and make sure they are calculating their tax liability properly, she says.

Offshore captives that are non-953(d) treatment—ie, they are non-US tax paying entities—should be wary of changes from the act to passive foreign investment company (PFIC) as well as the controlled foreign corporation (CFC) rules.

According to the IRS, a PFIC is a foreign-based corporation where 75 percent of its gross income is derived from investment rather than from the company’s regular business operation, and where at least 50 percent of the company’s assets are investments that produce income in the form of earned interest, dividends or capital gains. PFICs can include foreign-based mutual funds, partnerships and other pooled investment vehicles having at least one US shareholder.

A CFC is any foreign corporation where more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by US shareholders.

Steinman suggests that the new base erosion anti-abuse tax (BEAT), which could affect large corporations, could go two ways.

“If you have a US captive with foreign insureds, the claims paid by the foreign insured may be subject to BEAT. If you have a US insured that is paying premiums to a non-US tax-paying captive, it may also be subject to it,” she says.

Growth opportunities

“It has become the norm to have a captive as a risk management tool,” says Steinman. “It’s one of the many tools that risk managers and CFOs have at their disposal.”

Aon’s Global Risk Management Survey 2017 highlighted that captives continue to be a popular way for clients to finance risk, with considerable interest in forming a new captive or protected cell company (PCC) in the next five years, especially in North America, Asia-Pacific and the Middle East.

The survey showed that in North America, 9 percent of respondents plan to create a captive or PCC in the next three years. This is largely driven by factors such as increased confidence gained by industries from positive economic growth in the last five years, growing interest in captives from middle market and upper middle market organisations, and continued improvement in the science applied by organisations to assess, quantify and mitigate their own risk.

The most popular lines underwritten, according to the report, are property damage including business interruption and general liability. There has also been a significant amount of interest from companies looking for way to use their captive to underwrite cyber coverage, and the report states that cyber liability represents the third fastest-growing cover to be retained by captives.

Twelve percent of respondents to Aon’s survey reported that that they utilise their captives for cyber coverage, up from 8 percent in 2015. However, the use of captives in cyber is projected t o rise from 12 percent to 23 percent by 2020.

The survey also reveals an increased use in captives underwriting employee benefits, as multinational companies use these programmes to reduce expenses, retain cash flows, align risk retention with group risk appetite, and gain greater transparency of programme data.

by whom?

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Bermuda analysis
26 March 2018   Peter Mullen, the Bermuda-based chief executive officer of Aon Captive and Insurance Management, is stepping down from his position.

More on this story

Bermuda analysis
26 March 2018   Peter Mullen, the Bermuda-based chief executive officer of Aon Captive and Insurance Management, is stepping down from his position.