Ken Read looks at the issue of captive redomiciliation
The hard market has encouraged many organisations to consider the captive option and, consequently, the captive sector has seen major growth in recent years. Domiciles have been reporting impressive growth in the number of captive formations, in particular the Cayman Islands, Vermont, Bermuda, the British Virgin Islands, Guernsey and South Carolina. Indeed, Vermont has broken records in both 2002 and 2003.The captive option remains as viable as ever, with an ever-growing array of captive domiciles to choose from. The number of domiciles has nearly doubled in the last decade and there is much competition for new captives.A number of existing captive owners have carried out or intend to carry out a captive strategic audit/review to ensure their captive continues to fulfil all of its parent's risk management and risk financing requirements in the hard market. Any captive strategic review should consider where the captive is domiciled and whether relocation is required.There are occasions when it becomes necessary to move a captive from one domicile to another, known as redomiciliation. Generally, the principle is that companies can migrate from one jurisdiction to another. However, it becomes more complicated when those companies are regulated and any difficulties with redomiciliation of captives tend to arise because of regulation.
Redomiciliation legislationSome domiciles have brought in redomiciliation legislation specifically to ease this process. The first to do so was the Isle of Man in 1996, followed by Guernsey, Gibraltar, Malta, Bermuda, British Virgin Islands, Mauritius, Cayman Islands, Jersey, St Lucia and others.Redomiciliation regulations give a legal framework to the process of moving to or from a regulated environment. It should be noted that such legislation does not give a right to redomicile and the approval of the regulators in both the departure and recipient domiciles is needed. It should also be noted that where there is no redomiciliation legislation, it does not necessarily mean that it is impossible to redomicile.Redomiciliation usually allows a captive to relocate to another domicile and keep all its existing insurance and reinsurance agreements in place.It avoids the need to close down the captive and go through the whole establishment process again in the new domicile, thus cutting down on bureaucracy, costs and administration.As an example of redomiciliation legislation, the Isle of Man law states that: "An insurance company incorporated outside the Isle of Man and writing only 'captive' business, either direct or as a reinsurer, may apply to the Insurance Supervisor under Section 25A of the Insurance Act 1986 for redomiciliation to the Isle of Man."It adds: "Applications must be made in the forms prescribed and accompanied by copies of the existing memorandum and articles of association, certificate of incorporation, present insurance authorisation (or licence), memorandum of continuance and proposed new articles of association."The supervisor will require to be satisfied:-(a) as to the nature of any existing charges over the applicant's assets, those that have interest in such charges and that adequate notice has been given and, in the event that consent is given,(b) that in all other respects the proposed insurance company satisfies the requirements for authorisation (including business plan, management, directors etc.)."The Offshore Group of Insurance Supervisors produced a guideline in 2002 entitled "Regulatory Responses to Captives Changing Domiciles". In the advice to regulators, the guideline says that the new regulator should ensure that there has been a recent independent audit of the captive and that the captive provides a declaration of solvency. The guideline also advises that the current regulator must have approved the move, the captive should be in good standing with the current regulator and should have filed the required statutory reports on a timely and accurate basis in the past. It also recommends that the new regulator should find out "whether or not the current regulator has performed due diligence checks on all persons involved in the captive and is satisfied that there is no illegal activity being carried on."There are some domiciles, such as Ireland, where the regulator has taken the view that they will not allow an offshore insurance company or captive insurance company to redomicile. This is, presumably, because the domicile is anxious to protect its reputation and prefers a company to start off on day one with a clean balance sheet, thereby avoiding any possible 'skeletons in the cupboard'.Equally, it would be unlikely for an onshore EU regulator to allow an insurance company, particularly if it is or has been writing third party business, to migrate offshore, largely because of the need to continue to protect the policyholders.In reality, despite the existence of redomiciliation legislation, there isn't a lot of movement of captives between domiciles. This is because the original captive feasibility study will, or should, have covered the choice of domicile in some detail; unless there has been a significant shift in the parent's circumstances, it is unlikely that a clear advantage could be obtained from redomiciliation. In addition, it is likely that the captive and its parent will have built up relationships with the regulator, the captive manager and other support services. Moving the captive would involve disturbing those relationships and arrangements.
Reasons for relocationHaving said that, there are a number of possible reasons for a captive relocating to another domicile. The move may be in order to save time and money by having the captive closer to the parent organisation, or it may be to take advantage of specific legislation. It could also be the result of group rationalisation.For example, redomiciliation can be an attractive option where organisations have a number of captives as the result of mergers and acquisitions' and wish to bring some or all of them together in one domicile, perhaps ultimately to merge them. The benefit of having all the captives in one domicile is to do with economies of scale: one manager can be used for all, and meetings of the captive's boards can be scheduled for the same day. It is a much more favourable structure than having captives in different locations and different time zones, which can be cumbersome.While there has been an increase in captive formations, there has also been an increase in the number of captives being closed down. For example, in 2003, Guernsey added 32 captives, but 31 captives were removed. A major reason for this is the rise in merger and acquisition activity at the end of the millennium, as a result of which many organisations ended up with several captives.Following a merger or acquisition, the new organisation will have many priority issues to be addressed, not least in the insurance and risk management area. The question of what to do with multiple captives will, typically, take two to three years before it comes to the fore. As a result, there is a number of organisations which merged or made acquisitions three or four years ago that, having been through a strategic review, have implemented the recommendations arising from those reviews.There are, of course, alternatives to redomiciliation and merger of captives.A parent company could instead establish a new captive, and transfer the business of the existing captive to the new one in, as far as is possible, via novation. Alternatively, it could put the existing captive into run-off and, if it is felt necessary, reinsurance could be purchased to limit volatility in the results of the captive whilst it is in run-off. However, this option is not necessarily efficient in terms of cost and the parent would need to leave the old captive in place for the duration of the run-off.
Movement between domicilesMuch of the redomiciliation that has taken place has occurred between the leading European domiciles and the leading US/Caribbean domiciles.There have been some UK-owned captives based in Bermuda that have relocated to the Isle of Man or Guernsey, largely because many UK-parented captives were initially set up in Bermuda but the parents are now keen to have the captives closer to home. The Isle of Man, for example, reports that eight captives have redomiciled to the island, of which seven were from Bermuda.Another factor that could lead, potentially, to an increase in redomiciliation is the tendency for companies to consider onshore direct writing captives, primarily to avoid fronting fees and related security requirements such as letters of credit. This is especially so in relation to the EU and is, therefore, relevant to onshore EU domiciles. However, as explained above, Ireland does not have redomiciliation legislation and accordingly, it is possible that there will be more captives attempting to redomicile in Gibraltar and, possibly, Malta or Cyprus now that these will soon be part of the EU.Looking to the future, the stock markets continue to recover and, in due course, this may well fuel an increase in merger and acquisition activity.In a few years' time, therefore, we could see further rationalisation of captives and, possibly, more redomiciliations.
The onshore trendHaving said that it makes sense to have captives in one location or to merge them, there are some instances where it can be advantageous to have more than one captive. If there is a trend in the captive sector, it is towards onshore captives. More complex structures, involving both onshore and offshore captives, are not unknown.For example, there are instances of companies with offshore captives setting up onshore captives in order to write direct, and then reinsuring part of the business with the offshore captive. This is seen especially in relation to global programmes, where an EU captive will write business in the EU directly, which will then be reinsured with a captive in an offshore location.It is interesting to note that a number of UK-owned captives have become resident in the UK for tax purposes. They remain offshore, for example in Guernsey, for regulatory purposes, but elect to be treated as a UK company for taxation. The advantages of this are the simplification of the UK group's tax position and the potential to offset losses in a captive against profits in the parent.The potential for relocation of a captive has been vastly improved by the introduction of redomiciliation laws in some domiciles. Though there may be a number of reasons why a captive may seek to relocate to another domicile, the root cause is mainly rationalisation of some form. With the global economy showing signs of improvement, and mergers and acquisitions activity expected to increase, the next few years may see greater activity in the area of redomiciliation.