Changes in the European captive landscape over the past year.
The past 12 months have seen the first meaningful hardening of the re/insurance market for many years and a popular, and well-supported, theme arising from this transformation is that the captive industry will benefit and could see a dramatic increase in growth.
The annual growth of captives over recent years has been steady at around 5% per year, but upon closer examination it can be seen that a great deal of this growth has been focused upon Bermuda and Caribbean locations, such as the British Virgin Islands and the Cayman Islands, which tend to be favoured by clients based in North America. The Caymans have also benefited from introducing segregated cell legislation with a 59% growth in segregated portfolio companies in 2000. According to the 2001 AM Best Captive Directory, over 75% of new captive formations in 2000 were in the Caribbean region or onshore US domiciles. This suggests that formation of new European captives has not been a main feature over recent years.
A closer look at the development of the traditional captive domiciles for UK and continental European companies over recent years lends further weight to the argument that here has been an apparent lack of growth in new European captive formation. Apart from the impressive increase in the number of protected cell captives in Guernsey under fairly recently-implemented legislation, it is fair to say that growth of traditional captives in the established European domiciles of Guernsey, Isle of Man and Luxembourg have more or less stood still on a net basis (taking into account new formations and liquidations).
Figures issued by the Guernsey Financial Services Commission show 353 captives at 30 April 2001 compared to 347 a year earlier, an increase of less than 2%. In 2000, the Isle of Man slipped down in the domicile league table, with only two new captive formations, going from seventh internationally to ninth, and changing positions with BVI.
Over the last decade, the International Financial Services Centre (IFSC) in Dublin, with its ability to issue direct insurance policies into other European Union countries, has given Ireland the edge in selling itself as a captive location to companies from the EU, particularly Belgium, Holland, Sweden and Germany, and continues to show steady growth. However, part of this growth can be attributed to US captive owners which have realised the benefits of insuring their European risks directly from the IFSC without the need for fronting.
The transition in the standard rate of Irish corporation tax on a phased basis to 12.5% by 2003 reflects a 25% increase in the rate currently paid by existing IFSC companies and although an extension of the 10% rate until 2005 for such companies applies, the new tax structure may lead to a drop in captives locating in Ireland over the next few years. Gibraltar also offers cross-border policy issuance and is on the verge of introducing specific protected cell legislation, something the Irish regulators seem to be resisting.
So what has restricted the growth in European captive formation? Certainly low insurance prices have acted as a disincentive to self-insurance and, for certain well-developed parent ‘captive' countries such as the UK and Sweden, many major national and multinational companies already have existing and well-established captives, thus growth will have naturally slowed. Mergers and acquisitions resulting in a company owning more than one captive will have also had an effect.
The main influence on the captive landscape over the last 12 months in the UK has come from increased legislation with the further tightening of Controlled Foreign Companies (CFC) rules in the Finance Act 2000 and the introduction of discounting of general insurance reserves, announced by the UK Government at the end of last year, which came into force at the end of May. This will have a considerable impact upon those operating in the UK market including owners of UK captives, regardless of their domicile.Lloyd's seems to have finally brought the curtain down on its attempt to set itself up as a viable alternative to the established captive domiciles with the announcement that a strategic review is expected to lead to a decision not to pursue captive business.
Lloyd's, rather interestingly, has now decided that captives are often established primarily with tax considerations as “their primary focus” and may not be “geared up for profitable underwriting as other syndicates and agencies in Lloyd's”. This is, of course, nonsense, and Lloyd's should look inwardly as to why this expensive foray into the captive market has failed rather than come up with such poor excuses.
In Sweden and Denmark, there is uncertainty over the impact on the future tax position for companies with captives following recent announcements by the Finance Ministers of those countries concerning CFC legislation and premium tax deductibility. The changes in Denmark relate to how Danish and non-Danish risks are to be treated, but this has created a great deal of interest in the cell captive structure which may provide a beneficial solution.
Another country with an established captive history is the Netherlands, with captives located both domestically and offshore. A favoured offshore domicile is the Netherlands Antilles which offers advantages to Dutch-owned captives in so far as payment of dividends back to the parent do not incur additional Dutch corporation tax. However, the number of captives in the Netherlands Antilles has not altered from 1999 to 2000, again suggesting that saturation point for captive formation may have been reached amongst Dutch companies.
The tax issue has again been a feature in the development of French captives which traditionally have been drawn to domicile in Luxembourg by attractive tax deferral benefits, in addition to its geographic proximity and common language.
The main issue is the treatment of catastrophe reserves whereby Luxembourg-domiciled captives are allowed to establish reserves of 12.5 to 20 times average annual net premium over the preceding five years, known as ‘equalisation reserves', untaxed. The Commissioner of Insurance in Luxembourg has stated that a number of French-owned captives have shut for business or are closing down due to hounding from the French tax authorities; however, there is still room for optimism as a number of recent court judgments in France have ruled against the French tax authorities. The Commissioner is confident most French-owned captives will remain and new ones will be formed.
German interest in captive formation has been limited, although several large German companies have, for many years, formed and domiciled insurance subsidiaries within Germany. However, the ‘captive' tag has not been attached to them. Influences within the German market and the attitude of the tax authorities have restricted growth in offshore-based captives, but slowly this concept is gaining interest and Germany is one of the major potential growth areas for captives over the next few years.
Similarly, Southern Europe has not been a major contributor to the captive market. With the emergence of new offshore financial centres such as Malta, Cyprus and Mauritius together with the seemingly determined approach by Gibraltar to establish itself firmly on the captive domicile map, countries such as Spain, Portugal and Italy offer perhaps the best opportunity for captive development in Europe.
Switzerland, although outside the European Union, has fared quite well as a relatively new captive domicile for domestic clients and providing clients for other locations, notably Bermuda and Dublin. The potential Switzerland offers as a major European domicile is significant arising from its overall image and commercial attitude of encouraging foreign capital to the country. There is a notable potential for new captive growth.
In conclusion, the past year has, with the exception of one or two locations, been fairly lean for new European captive formation but there are a number of positive factors that could lead to increased activity in the near future, in addition to the hardening market. These include the continuing standardisation of insurance activities within the EU through freedom of services, increased membership of the EU by Eastern European countries, and specific legislation by offshore domiciles, established and new, designed to encourage new captive initiatives.
Against this must be measured the increasing interest and determination of the tax authorities in some of the historically less mature captive countries to legislate against the potential tax benefits a captive may offer. Finally, the ultimate conclusion of the Organisation for Economic Co-operation and Development (OECD) effort to outlaw offshore tax havens will have an impact on captive development within Europe, and elsewhere, with Guernsey currently top of the list as potentially the biggest loser and the co-operating nations benefiting.