Virtual captives are increasingly seen as a solution to external influences on captives such as rising premium taxes, tighter controls on controlled foreign companies (CFCs) and more onerous accounting standards. The term virtual captive is used to describe the process by which responsibility for the management of an internal insurance fund is delegated to an external specialist.

The main purpose of the exercise for a company /group is to free up scarce resources within its insurance department while at the same time being confident that the fund is being managed to a professional standard.

Why are virtual captives increasing in popularity?

  • Many groups are taking on increasing amounts of self-insurance (driven by rising levels of insurance premium tax);

  • The reconciliation and management of insurance funds are an administrative burden;

  • Insurance departments are often under-resourced;

  • External specialists have the necessary skills;

  • Outsourcing does not increase headcount;

  • The group's treasury department retains control of the cash;

  • Virtual captives do not require formal structures in the same way as captives or protected cells;

  • They can generally be put in place without main board approval.

    Advantages and disadvantages compared to a normal captive operation

    Advantages

  • Reduction in insurance premium tax (IPT) liability;

  • Increase in return on assets used as these are maintained within group facilities;

  • Simplification of tax related issues;

  • Considerable reduction in management time;

  • Decrease in third party costs (although not necessarily those of the manager);

  • Efficiencies, as reporting is internal

  • Potentially simpler to add or remove parts of the programme;

  • May reduce security and letter of credit requirements;

  • Effective tracking of funds.

    Disadvantages

  • Reduction in the formality of the insurance process;

  • Internal funds may be “raided” for other purposes;

  • Loss of premium tax deductibility;

  • Loss of potential for offshore tax planning;

  • Loss of potential for roll-up of investment income on long-tail policies/programmes.

    What makes up a virtual captive?

    Each virtual captive is unique. However, the insurance manager will typically offer a number of services including:

  • Intra-group premiums;

  • Allocation;

  • Debiting;

  • Collection - internal and external (via insurers);

  • Reconciliation;

  • Remittance to insurers.

    Claims

  • Handling;

  • Payment;

  • Loss recoveries;

  • Reporting;

  • Aggregate erosion;

  • Reserving;

  • Actuarial studies.

    Bank accounts

  • Reconciliation;

  • Cashflow forecasting;

  • An appropriate investment programme.

    How does a virtual captive cover overseas risks?

    Where the group operates in territories which require local policies, the programme will need to be fronted in the usual way. The insurer will deal with local taxes and then pass the net “premium” to the fund.

    Are long-term liability policies suitable for virtual captives?

    The potential advantages of using virtual captives as opposed to more traditional self-insurance mechanisms are reduced for long-term business. This is because the use of an offshore captive for such business allows a tax-free roll-up of investment income over the claims payment period (“tail”) of the programme, potentially considerably reducing the effective cost of claims to a group.

    A solution is to combine a virtual captive with another self-insurance mechanism, such as a protected cell company (PCC). This provides the advantages of offshore “captive” insurance with reduced costs to that of the traditional captive.

    How much does it cost to run a virtual captive

    The cost of the product depends on the nature and complexity of the tasks. A detailed specification needs to be drawn up before any meaningful price can be given, but experience to date has found costs to be in a range of £15,000 - £40,000.

    Will more companies be looking for the virtual solution and might they replace conventional captives?

    Virtual captives should not be seen as a total replacement for but as complimentary to the standard captive. Aon Insurance Managers (AIM) Guernsey has developed a number of virtual captive programmes and already has four in operation. “We have virtuals combined with cells of a PCC or captive so that the risks are blended but still administered by ourselves as captive manager,” says Clive James, managing director of AIM Guernsey. “ We see this as an exciting development, not just for the United Kingdon but for Europe and the rest of the world. As captive managers we have to be fully aware of changes in fiscal and financial environments and virtuals provide a flexible solution while maintaining control over the risks. I would expect that we will have a further six programmes by the end of 2000”

  • John Perham is executive director, Aon Insurance Managers, Dublin.

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