2014 Captive Benchmarking Report – The Evolution of Captives: 50 Years Later
Among the most popular risks included in captives, general liability has the lead, with 30.8% of benchmarked captives writing this line of coverage, closely followed by property risk, with 29.4% of captives including this coverage.
Only 3% of captives obtain a rating. A.M. Best is the leading agency with 52% of all rated captives. A.M. Best reported that it rated 18 captives and three risk retention groups in 2013. A.M. Best is followed by Standard & Poor’s with 30%, and Moody’s with 18%. Benefits of a rating include improved leverage with fronting carriers and reinsurers, and compliance with contractual terms.
There were significant developments in the UK in 2013 with controlled foreign corporation (CFC) laws, making captives more attractive to owners in the UK. Captives are formed for business and risk management reasons, and we have found that only 37% of US companies with captives actually achieve insurance company tax status and deduct premiums paid to the captive. In January 2014, the Rent-A-Center, Inc. and Affiliated Subsidiaries vs. Commissioner of Internal Revenue case represented the first significant decision on captive insurance company arrangements in more than 13 years. Although it did not change the captive tax landscape, this decision allows captive owners to review certain issues such as risk distribution, capitalisation, and intercompany investments with some fresh and recent guidance.
There was also a favourable case (Validus Reinsurance, Ltd. vs. United States of America) in 2014 that affects the payment of federal excise tax (FET) and makes the rules clearer for captive owners.
Small Captive Tax Election
There has been a tremendous amount of growth and interest in small captives that elect to be taxed on investment income, not underwriting income, in the US. Most of Utah’s captive formations in the last two years have been small captives, and other domiciles, such as Delaware, Montana, and Nevada, are starting to increase their small-captive share as well. Common coverages include high catastrophic lines such as excess liability and terrorism.
In the UK, there is a similar concept to the US small captives as a result of the 2013 UK CFC laws.
Captive Owner Insights
US companies own 58% of all captives, European parents own 28% and companies from the rest of world (such as Latin America, Asia, and Africa) own 14%. Despite the increased activity in emerging captive markets like Latin America, the dominance of US parent companies owning captives is a trend that will continue, with small captives remaining an area for growth.
Public Vs. Private and Profit Vs. Not-For-Profit Owners
There is a growing trend for private companies to own captives, mostly attributable to the growth of small captives. Currently, 52% of captives are owned by private entities, dispelling the myth that captives are only for large public Fortune 1000 companies. Not-for-profit entities account for 19% of all captives and represent health care organisations, churches, educational institutions, public transportation entities and municipalities.
The largest three domiciles – Bermuda, the Cayman Islands and Vermont – represent 36% of all captives. As more global and US domiciles are created, however, there is a trend toward emerging domiciles.
Global onshore versus offshore single parent captives remained flat in 2013 with 56% of captives being onshore and 44% being located in offshore domiciles.
With Solvency II set for full implementation in 2016, the insurance industry can, at last, proceed with final preparations for the introduction of the new regime and, as such, some new growth is expected in captive formations in EU domiciles. EU domiciles currently account for 28% of all benchmarked captives.
Emerging domiciles continue to grow, attract new business, and react to making their domiciles unique and marketable to new and old captives. Texas, New Jersey, Connecticut and Tennessee are looking to position themselves strategically and have developed regulatory infrastructure for large-scale growth.
We observed 11 re-domestications in 2013, down from 16 in 2012. This figure demonstrates that there is no large-scale movement of captives to onshore jurisdictions, as some had anticipated as a result of the enactment of the US Dodd-Frank Act. Texas, a new US domicile, is the only state we have seen to respond with enforcement measures and it has enacted legislation relative to self-procurement taxes, so some movement to Texas is expected.
On the terrorism protection front, 11.5% of captives participate in a terrorism programme. Of this group, 71% are accessing the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA, but commonly referred to as TRIA) in the US. Although TRIA is set to expire on December 31, 2014, most industry experts believe it will be renewed in some fashion, although with potentially higher trigger, deductible and quota share.
The Foreign Account Tax Compliance Act (FATCA) is a US Regulation – enacted in 2010 and taking effect in 2014 – aimed at foreign financial institutions (FFIs), which can include captives. Administrative reporting (IRS Form W8/W9) by foreign captive insurance companies may be required in certain scenarios. Foreign captives that make a 953(d) tax election to be considered a US corporation for tax purposes may not be required to file Form W8/W9 in certain cases.
Implementation of Solvency II takes effect on January 1, 2016 and the insurance industry can now proceed with final preparations for the introduction of the new regime. With these developments, we expect to see growth in captive formations in the EU domiciles. It is also encouraging to see some EU regulators applying the principle of proportionality to captives in their approach to the interim guidelines; hopefully, this can be taken as an indication of how they will regulate captives under the new regime.