Captives grow in Latin America’s green fields

Recent regulatory and legislative developments have meant the use of captives is under more scrutiny, particularly where offshore domiciles are involved. A tougher stance on compliance is being taken across the Latin American region but as part of a more general effort of increasing tax and fiscal scrutiny on cash flows to and from foreign entities, particularly to offshore and low-tax jurisdictions.

Examples of this tougher stance are the issuance of revised ‘black lists’ including new jurisdictions by Mexico, Colombia, Chile, and, it is anticipated, many Central American countries. Furthermore, the introduction of risk-driven regulations (Solvency II type) in countries like Mexico, Colombia, Brazil and Chile, will increase the costs of capital for local insurers, which eventually will result in an increase in fronting fees.

Argentina and Venezuela remain the most challenging jurisdictions for captive business, and to a lesser degree, Brazil, Ecuador and Bolivia. On the other hand, local authorities in key markets such as Mexico, Colombia, Peru and Chile and even Brazil, have become more focused in bringing more transparency to the captive insurance business facilitating the use of well-known traditional captive domiciles such as Bermuda and Barbados, by signing Beneficial Double Taxation Agreements (DTA’s), Bilateral Investment Treaties (BIT’s) and Tax Information Exchange Agreements (TIEA’s), thus removing these domiciles from the ‘black lists’.

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Legislative complexity is the only truly consistent feature of the Latin American region and it is considered by most of the region’s risk managers as the key challenge. The World Economic Forum has identified many of the countries in the region as among the worst performers in terms of “Ease of doing business” and “Burden of government regulation”.

Most captive jurisdictions are under legislation that follows Anglo Saxon common law, whereas Latin America has a separate civil law tradition. Legal firms specialised in captive business in both the Cayman Islands and Bermuda have been hiring civil law lawyers to address the needs presented by Latin American clients. This trend is occurring as captive insurance strategies find greater appeal among smaller organisations.

As a consequence of such significant differences in legal systems, even from country to country, but also due to very conservative insurance regulations with tough consumer protection laws, it makes it difficult and complex to adapt specific wordings for insurance policies according to insured’s needs, particularly for complex covers.

Tailor made policies and clauses have to go through long approval processes particularly if cover is being limited, in addition to having to produce accurate translations, legally approved. DIC insurance has become a common solution for these issues, but if not properly assessed and limited it may also create additional legal uncertainties.

Cross-border regulatory collaboration

There is growing cross-border regulatory collaboration in Latin America, mainly due to Free Trade Agreements and the increase of laws focused on fighting money laundry activities and financial transactions.

Captive domiciles are more and more seeking to reach tax agreements with many Latin American countries in order to exclude them from the ‘black-lists’. Nevertheless, this growing collaboration continues to be limited to a few countries, whilst significant differences amongst their legal systems prevail.

In recent years, there has been a trend towards a ‘progressive’ modernisation of otherwise outdated regulatory frameworks, along with a better perception of the inherent benefits that captives bring, particularly in the most developed economies like Mexico, Chile, Colombia, Peru and Brazil (in spite of the challenging regulatory environment). This trend has definitely supported the growth of captive business in the Latin American region, and facilitated the use and even expanded the market share of the most recognised captive domiciles (Bermuda and Barbados).

This has been mainly achieved as a result of the willingness to cooperate between the Latin American authorities and the captive’s local insurance authorities, by reaching cooperation agreements for tax rates and tax and financial data exchange.

Tax differences

Some countries are more challenging than others. For instance, Ecuador recently passed a law whereby local companies’ reinsurance cessions have percentage caps for most lines of business. In principle the tax on reinsurance premiums is 22%.

If an Ecuadorian company complies with the cession caps, the regulator will waive 75% of the tax so the effective rate would become 5.5%. If the company cannot comply with cession caps, the regulator will only waive 50% of the tax, meaning the applicable rate would be 11%. The above is true provided the reinsurer to whom the Ecuadorian carrier pays the reinsurance premiums is not domiciled in a country deemed as a tax haven by the Ecuadorian regulator. Should the recipient of Ecuadorian reinsurance premiums be a reinsurer domiciled in a tax haven, the applicable tax is 35% regardless of cession caps compliance. And in addition, all Ecuadorian carriers must pay a 5% withholding tax when making payments abroad.

Venezuela and Argentina are the most difficult countries in terms of tax and legal issues, but also regarding currency exchange and political risks that create a burden that is very difficult to overcome when it comes to setting up captive arrangements. Brazil also remains a very challenging market in which to do business, but due to the large industrial and commercial growth experienced in recent years and strong interest in better managing their risks, some of the largest insurance players are able to offer effective captive insurance solutions.