What perhaps separates Zurich from the other captive domiciles today is the immense concentration of capital and know-how, writes Hans Erik Engelbrekts.
Switzerland is experiencing continued growth of captive related activity. Since our last update in 1998, a couple more countries can be added to the list of parent company domiciles. Captives managed by Nordic Mutual in Zurich, Zug and Neuchâtel (a new domicile within Switzerland) now have parents from Denmark, Germany, Mexico, the Netherlands and Sweden. We are very pleased with the awoken interest from German clients, which is new to the domicile, as well as the continued good response from our main market - the Nordic countries.During the last year, Nordic Mutual has successfully launched its cell captive concept, and now operates two such captives. The cell captive can be compared to the protected cell company (PCC) and we will briefly detail the fundamentals of the structuring and operation of a cell captive company further in this article.As the Allfinanz concept tightens its grip of the financial industry, banks, consultants, insurers, reinsurers and others now focus more on clients' needs and develop solutions to fit these needs rather than relentlessly pushing their respective standard products. For example, we now operate insurance programmes as an important part of larger financing schemes. Furthermore, we are currently investigating to what extent means of securitisation can contribute to a client's portfolio in terms of alleviating risk transfer and freeing up capital. These products are in the twilight zone between insurance and banking or a mixture of both and it is essential to have this type of know-how in order to be able to fully service the needs of the clients.
Recent amendments in the Swiss taxation system ensure that Switzerland stays competitive in the European arena. For a captive domiciled in Switzerland, the following taxes apply: stamp duty (1% at the issuance of share capital), capital tax and income tax. Taxes are deductible expenses and all rates are therefore expressed as shares of the after-tax profit in Switzerland.
Federal capital tax was abolished in 1998. The former rate was 0.08% of taxable equity. The capital tax rate in the Canton of Zurich is 0.075% for captive companies.
Regarding income tax, at the federal level, a flat rate of 8.5% is levied on the profit. As a result of the Master ruling on captives, only between 10% and 15% of the after-tax profit is taxed on the cantonal level. Profitability is measured as a share of taxable equity. The basic cantonal rate is 4% of after-tax profit. Profit above 4% profitability is taxed an additional 5%, and above 8% yet another 5%. However, in the current tax code, tax is limited to 10% of after-tax profit. That limit is reached when after-tax profit is 15% of average capital. The cantonal profit tax is finally multiplied by the Steuerfuss.
The final combined federal and canton income tax rate (before tax income) in Zurich is thus at minimum 9.09%, and maximum 10.91%.
Captives in Zurich are granted the possibility to reserve for extraordinary events in the so-called equalisation reserve. Such a reserve is created, for example, for failure in the reinsurance protection, currency collapses and similar events. Surplus amounts generated in the captive after reserving into reported claims reserve and IBNR, can be put aside, pre-tax, to the equalisation reserve. During the first two years of operation all surpluses can be put aside into the equalisation reserve. As from the third year some surpluses have to be shown as profit. The Master ruling prescribes that the minimum profit to be shown shall correspond to an equity yield of Swiss governmental bond interest plus 2%.
The generous and flexible reserving facilities makes the growing use of the captive as carrier of the owner's risk capital in ART solutions particularly appealing. Unused fund reserves can be reinvested in other ART solutions or de-invested out of the scheme, via captive income to free equity and returned as dividends, or returned directly as claims bonus.
The cell captive
In 1998, Nordic Mutual developed a structure for establishing and managing cell captives. In short, the cell captive is operated as a number of separate cells, which are consolidated as one entity for the year closing and authority reporting (however, the Swiss Insurance Commission also keeps track of the individual cells' performances). Each cell is internally protected by the wording in the shareholders' agreements, by a Letter of Guarantee and/or mutual reinsurance.Acquiring a cell is as easy as buying shares in any other company, vastly facilitating the decision making process and establishment of a captive. The various shareholders each have a specific share category and can themselves set the terms for dividend payments, etc.
Nordic Mutual has operated two cell companies since the beginning of the year and will have another operational by the end of the summer. The incorporated captives have three and 15 parents respectively. The owners of both companies are fully separate entities, but have some common structure and business, and thus a similar risk profile. By joining forces in a cell captive, these groups of companies can now take advantage of the traditional single parent captive benefits as well as utilising their respective size to obtain bulk purchasing power in the reinsurance market.
For a group of companies with not so common business, it is possible to organise the cell captive in a slightly different manner. This requires a cell captive “host”; often an insurance or reinsurance company that can guarantee to hold the individual cells harmless in case of a defaulting cell or cells. This type of captive company structure is fairly close to the PCC framework found in other domiciles. The main difference is that the cell in a Swiss cell captive is not protected from other cells by law, but must be protected by any of the methods mentioned above.
Zurich - bright future
Zurich continues to develop as a major centre for financial engineering and ART solutions. We believe that captives, together with other sorts of special purpose vehicles (securitisation SPVs, for instance), will play an increasingly important role in this context. What perhaps separates Zurich from the other captive domiciles today, and probably even more in the future, is the immense concentration of capital and know-how - always ready to be deployed for new ventures.And how did we get here? The main reason for Zurich's success lies in the continuity that the domicile offers in terms of a stable currency and interest rates as well as a fiscal policy that encourages investments. We do not foresee any changes that will impede these factors.
Hans Erik Engelbrekts is managing director of Nordic Mutual CMO Zurich AG.
Established in 1991, Nordic Mutual is a captive management organisation. The firm currently manages 16 captives, of which two are direct insurance captives, two are cell captive, one is a group captive and the remaining 11 are single parent reinsurance captives.