Offshore domiciles remain a favourite choice for establishing group captives. But it is important to first consider the potential regulatory and tax risks, warns Praveen Sharma.

In this present economic environment many risk managers are under pressure to manage insurable risks effectively whilst lowering the total group cost of risk.

The involvement of a group captive in the overall insurance programme to write risks on a direct basis may reduce immediate costs, but it could also give rise to non-compliance with insurance regulations and unexpected tax costs.

While the use of a captive can provide many benefits, they do need to be considered carefully. When structuring global programmes involving captives, multinational companies need to acknowledge the insurance regulatory and tax parameters within which the captive has to operate. Unfortunately, this is not always straightforward because insurance regulations in some domiciles are ambiguous and open to wide interpretation.

This is particularly acute in countries that strictly prohibit non-admitted insurance and require risks located in their territory to be covered by locally-licensed insurers. In these cases, companies with very large global exposures sometimes find it

difficult to buy cover from credible local insurers that satisfies their specific needs at an acceptable cost. Companies might be tempted to use the group captive to participate on the excess layers or provide DIC/DIL (difference in conditions/limits) cover on a non-admitted basis. But this could place the multinational company and its group captive at greater risk.

Increasing tax pressure

“In Canada and certain parts of the EU, tax authorities are aggressively targeting multinational companies.

Given pressure on the fiscal positions of many governments around the world, tax authorities are likely to be required to assist by generating higher tax revenues. This could conceivably include a campaign to collect unpaid insurance premium taxes. Any failure by a corporate to comply with the local premium tax laws could give rise to interest and penalties in addition to any unpaid tax, for the current period and retrospectively for both the insured and the insurer, including captives.

For instance, in Canada and certain parts of the European Union (Germany, Austria and Belgium), tax authorities are aggressively targeting multinational companies. They are scrutinising global insurance programmes to determine potential unpaid premium taxes, interest and penalties. They are also challenging the premium allocation methodology – whether or not the premium is recharged. There is no sign of this approach abating and if anything this practice is likely to escalate in the major territories.

Additionally, various tax authorities have tightened the transfer pricing, controlled foreign company tax legislation and requirements to justify deductibility of technical reserves. All these measures would have a direct impact on the operation of captives. Therefore, captives will to need to ensure that their activities and transactions with connected parties are commercially justified.

John F Kennedy once remarked that: “There are risks and costs to a programme of action. But they are far less than the long-range risks and costs of comfortable inaction.” Companies should conduct a careful evaluation of how best to reduce unnecessary costs associated with non-compliant global insurance programmes. Any approach and subsequent implementation should achieve a delicate balance between the multinational company’s attitude to compliance, its insurance needs and the total cost of risk. The eventual structure should be commercial, realistic, practical and pragmatic without compromising the quality of cover required.

Praveen Sharma is the global practice leader of the Insurance Regulatory and Tax Consulting practice at Marsh.

The captive approach

To reduce avoidable costs, multinational companies and the group captive should adopt a commercial and analytical approach.

They should consider:
• Where is the insurable risk located and can it be covered by a preferred global insurer either on an admitted or non-admitted basis?
• What is the potential maximum exposure in that locality and could the risk be covered by a global insurer at reasonable cost?
• What are the local insurance needs?
• What are the local insurance regulations, and are there any exemptions or dispensations available?
• Can the preferred global insurer(s) pay for any losses in that jurisdiction directly?
• What role can the captive play on the
global insurance programme without compromising the insurance regulation and tax laws of the country in which the risk is located?
• What are the cost-benefits including effect on solvency and capital requirements for the captive?