Luxembourg attracts a steady stream of new reinsurance captives despite the debate over the taxation of equalisation reserves.

In the eyes of the Luxembourg Financial Commission, its captive insurance legislation is a prudential way of regulating reinsurance companies; in the eyes of some tax authorities, particularly the French, it is something different.

Luxembourg's legislation not only allows but specifically requires that a captives profits are transferred to equalisation reserves on which no tax is paid. The only straightforward way of getting money back to the parent company is by means of loans. If the company is wound up, then corporation and local taxes are payable on any profits in excess of the reserves actually needed to meet claims at the Luxembourg rate, which works out at about 36%.

At the end of April, the domicile had 255 captives with three companies currently being licensed. A total of 11 companies have been added to the register since 31 December 1996, the date of the last annual report.

At that time, the nationality of captive sponsors was as follows:

French 73

Belgian 59

Scandinavian 42

Luxembourgois 24

German 12

Spanish and Portuguese 11

Dutch 9

Japanese 5

Others (mostly Italian) 9

For some time, French owners of captives have been under scrutiny by the country's tax authorities, usually known as le fisc, who have been trying and having some success in recasting the accounts of French owned Luxembourg captives and subjecting them to French insurance taxes as stand-alone entities. Although there is a double taxation treaty between France and Luxembourg, in certain circumstances, the parent can find itself paying both taxes in both countries, a total of 75%.

The situation has, admits Marc Lauer a member of the board of the Commissariat of Insurance with responsibility for reinsurance and non-life insurance, stemmed the flow of new applications from French companies. He says that the French tax authorities are not just looking at captives but at the whole insurance industry, and he believes that the Luxembourg reinsurance industry has approached the European Commission over the potentially anti-competitive aspects of the policy. Mr Lauer adds: "We have legislation and we continue to apply that legislation, which we think is good."

Mr Lauer sees it as the classic difference of opinion between insurance regulators who like generous reserving for prudential reasons and the tax authorities who do not like it for tax reasons. He points out that there is still a flow of demand for new licences from other places.

The total assets of Luxembourg's international reinsurance companies at the end of 1996 were LuF 350 billion ($9.5 billion), although it is important to note that the figures include companies which would not be considered classic captives, such as bank rent-a-captives. The premium volume has been growing substantially, from about LuF 80 billion ($2.18 billion) in 1995 to LuF 100 billion in 1996, and increased further in 1997, according to Mr Lauer, though market figures are not yet available. "In the current year there will be some growth but as the traditional reinsurance market is very soft, sometimes captive owners may use them rather than their captive," he adds.

At the Luxembourg office of Deloitte and Touche, senior audit manager Susan Matthew explains that some captives have been set up for fiscal reasons but that for the majority, the main objective is a risk management one. She points out that where there is a fiscal motive: "It is tax deferral."

Deloitte and Touche audits about 30 captives and Ms Matthew sees the advantages of Luxembourg as ones of continuity: a skilled and multi-lingual workforce and stable political system and regulatory environment.

Perhaps surprisingly, it does not appear that many Luxembourg captive sponsors are using their ability to build up catastrophe reserves as a means of paying for uninsurable losses such as environmental pollution. "No," says Ms Matthew. "Most of them are doing traditional types of business, such as banker's blanket bond."

That very unchanging nature of captive business in Luxembourg may have its disadvantages, comments Hugh Rosenbaum, an authority on captives with Tillinghast-Towers Perrin. "Where licensing a captive in one jurisdiction could be the basis for licensing it in others, Luxembourg seemed an ideal base. That does not seem to be happening now and I am sorry to say that those who need multiple captives are not choosing Luxembourg."