Fiscal and regulatory pressure builds on captive owners

IPT was introduced in 1994 at a level of just 2.5% and has not been changed since it was increased to 5% in 1999. Jonathan Groves, Senior Vice President, Captive Consulting Leader at Marsh, believes an increase is now likely. “The reality is that IPT will be an easy tax to increase for the new government in terms of raising tax revenues,” he said. Mr. Groves pointed to two other areas that would impact captives. Firstly, IFRS Phase II which he said was bringing about a change in the way that assets and liabilities for a captive owner are valued in the effort to ensure that they are fair-valued on the basis of current values. Secondly, on a more positive note, a discussion paper published by the U.K.’s HMRC just before the British election focusing on changes to Controlled Foreign Company (CFC) rules could be beneficial to captive owners, according to Mr. Groves.hide“The document said they were considering focusing on reinsurance subsidiaries in particular and exempting the underwriting profits generated from overseas operations from the U.K. tax net,” he said. But, clearly the biggest topic, and the one causing the most concern to captive owners, is Solvency II and most of the live debate was taken up with discussion of its impact on the captive sector. Mr. Groves said the impact would be felt in three different areas: capital, governance and reporting and transparency. “We’ve recently had a calibration paper from CEIOPS and it has lightened off a little bit from where we thought QIS 5 [the fifth quantitative impact study] would be heading,” he explained. “There is still a lot of work to be done on the capital assessment side, but it is perhaps a little bit better than we were expecting. What we are still missing at the moment is some real direction from CEIOPS on the governance side and the reporting and transparency side, and they are perhaps the two harder areas for many captives to deal with.” Alan Fleming, Vice President of AIRMIC and Chairman of AIRMIC’s Captive Special Interest Group, said that a lot of the questions that AIRMIC has received from members were related to Solvency II. He explained that AIRMIC is supporting FERMA and ECIROA (The European Captive Insurance and Reinsurance Owners` Association) in their lobbying efforts over Solvency II. But, he explained that for AIRMIC, the issues are slightly different because most AIRMIC members do not have captives domiciled within the European Union. More than 90% of AIRMIC member captives are in offshore locations such as Guernsey, Isle of Man and Bermuda. Mr. Fleming said that one positive aspect of Solvency II is that it has triggered some thought about diversification of the types of risks that are carried in captives. The panel included a captive owner, Nicholas Bailey, Group Risk Manager, BBA Aviation plc, which has two captives, both writing only parent risks and programmes, one based in the Isle of Man and one in Vermont. Mr. Bailey said that Solvency II will affect the cost benefit analysis and will have some impact on the captive value. “But it is just one other factor that needs to be looked at and evaluated —it is all part of the annual review,” said the risk manager. “We don’t have captives in the E.U. and we are hoping that local jurisdictions will put in some equivalence and make life a bit easier for us. But, we obviously have to address the fronting issues for the European placements…I’m not holding my breath that the regulators will see the light in terms of single parent captives and the lack of consumer risk,” added Mr. Bailey. The panel was asked about the equivalence question. Under equivalence, non E.U. domiciles are able to write European risks without having to set up an E.U.-based company if the territory’s regulations are deemed equivalent to Solvency II. Mr. Groves explained that where an insurance company in the E.U. reinsures to a company, which is outside of the E.U., then the value of that reinsurance will be discounted. “In the case of a captive fronting arrangement, the reality is that in a lot of circumstances the value of that reinsurance is already discounted and that is why the fronting company is asking for collateral,” said Mr. Groves. “In our view, the cost of fronting should not change because the insurer is reinsuring to a thinly capitalised insurer in an offshore jurisdiction without a credit rating,” he said. Although these locations may not enjoy an equivalent jurisdiction, the fronting insurer is in the same position as before. This is because it already asks for collateral because it disregards the value of that reinsurance, he said. Mr. Fleming said that equivalence is a big issue and asked whether the offshore jurisdictions will go for equivalence. “If they do, that will be good in relation to fronting fees and the like. If they don’t, there are some issues. But, it would not necessarily be the end of the world and there could be some positives,” he said. He pointed out that Bermuda, Guernsey and the Isle of Man have not yet made a decision about whether or not they are going for equivalence for captives. In the case of Bermuda, he said they are determined to achieve equivalence for the activities of mainstream reinsurers. But the authorities have a totally different attitude towards captives, probably because they are in competition with the U.S., said Mr. Fleming, himself a former insurance regulator in Guernsey as well as a captive owner when a risk manager. Mr. Fleming said that the discussion in Guernsey, and probably the Isle of Man, is about whether there is a benefit in going for equivalence or not. If the issue is just capital then that is probably manageable, he said. But, he added that the real issue is governance. Mr. Bailey said that he hoped that external regulators see that equivalence and proportionality should come to the fore. “Solvency II may be the ‘elephant in the room’ right now, and has moved up the chart in terms of the things that we need to look at,” he said. “But with the soft market at the moment, a complete reappraisal of the captive may be warranted in any event,” continued the risk manager.

Fiscal and regulatory pressure builds on captive owners

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