British Virgin Islands: Captive Insurance

The British Virgin Islands Government has a very client-focused approach to the provision and regulation of financial services. The Insurance Act 1994, which governs all insurance-related business in the Territory, ensures the prudent supervision that is necessary to maintain the financial reputation of the BVI but also allows the greatest degree of flexibility in a captive’s business plan. The Act and the Insurance Regulations 1995 set out the obligations of those who own and operate captives but the flexibility of the legislation is such that the Act gives the Governor discretion to waive any provision of the Act or Regulations.

Some of the advantages of incorporating a captive in the BVI include:

• capitalisation requirements are not onerous and the minimum capital required may, subject to approval, be in the form of cash or letter of credit
• incorporation costs and insurance licence fees compare very favourably with other captive domiciles
• competitive professional fees
• applying for an insurance licence is relatively simple and well-prepared applications are processed quickly
• most captives are incorporated as International Business Companies, which enjoy BVI tax exempt status
• the redomiciliation of a captive to another domicile is permissible
• there is no requirement for the appointment of local directors or for licensees to hold board meetings in the BVI which can result in considerable savings in both cost and time.

In its simplest form, a captive an be defined as a wholly owned subsidiary of an organisation not in the insurance business whose primary function is to insure some or all of the risks of its parent. Since captives were first formed, the industry has looked at new ways of developing the captive model to provide appropriate vehicles for a wide range of different owners and users. There are now many types of captive, including:

• Single-parent captives - underwriting only the risks of related group companies.
• Diversified captives - underwriting unrelated risks in addition to group business.
• Association captives - which underwrite the risks of members of an industry or trade association. Liability risks, such as medical malpractice, are frequently insured this way.
• Agency captives - formed by insurance agents to allow them to participate in the high-quality risks which they control.
• Rent-a-captives - which are insurance companies that provide access to captive facilities without the user needing to capitalise his own captive. The user pays a fee for the use of the captive facilities and will be required to provide some form of collateral so that the rent-a-captive is not at risk for any underwriting losses suffered by the user.

A captive may be either a direct writing company or a reinsurer. Generally, and particularly in the case of smaller captives, it is simpler for the captive to operate as a reinsurer accepting the risks of its parent which have been insured by a licensed direct-writing company (the fronting company) and then ceded to the captive. The fronting company will charge a fee for its services and may require a letter of credit to guarantee the captive’s ability to pay claims. Where the risks to be covered can be written by a non-admitted insurer, or where the captive is admitted in the territory where the risk is situated, direct writing is possible.

It is popularly thought that a captive is primarily a tax minimisation device. In fact, captives are usually formed for other economic reasons with the main drivers being risk management and risk financing. Some of these reasons are summarised as follows:

Lower insurance costs.

Commercial market insurance premiums must be adequate to meet the costs of claims but, in common with other commercial enterprises, insurers are in business to make money and will therefore include in the premium an element to provide for their acquisition costs, overheads and profits. In establishing a captive, the parent seeks to retain the profit within the group rather than see it go to an outside party. A captive may also help reduce insurance costs by charging a premium that more accurately reflects the parent’s loss experience.

Apart from pure underwriting profit, insurers rely heavily on investment income. Premiums are typically paid in advance while claims are paid out over a longer period. Until claims become payable, the premium is available for investment. By utilising a captive, premiums and investment income are retained within the group and, where the captive is domiciled offshore, that investment income may be untaxed. Additionally, the captive may be able to offer a more flexible premium payment plan, thereby offering a direct cash flow advantage to the parent.

A company’s willingness to retain more of its own risk, particularly by increasing deductible levels, may be frustrated by the inadequate discount offered by insurers to take account of the increased deductible and by the fact that the company is unable to establish reserves to pay future claims. Establishment of a captive can help address both of these problems.

Where the commercial market is unable or unwilling to provide coverage for certain risks, or where the price quoted is seen to be unreasonable, a captive may provide the cover required.

A captive can act as a focus for the risk management and risk financing activities of its parent organisation. An effective risk management program will result in recognisable profits for the captive. A captive can also be used by a multinational to set global deductible levels by enabling a local manager to insure with the captive at a level suitable to the size of his won business unit while the captive only buys reinsurance in excess of the level appropriate to the group as a whole.

Reinsurers are the international wholesalers of the insurance world. Operating on a lower cost structure than direct insurers, they are able to provide coverage at advantageous rates. By using a captive to access the reinsurance market, the buyer can more easily determine his own retention levels and structure his program with greater flexibility.

Apart from writing its parent’s risks, a captive may operate as a separate profit centre by writing the risks of third parties. In particular, an organisation may wish to sell insurance to existing customers of its core business. For example, retailers may sell extended warranty cover to customers with the risk being carried by the retailer’s captive. The claims pattern of this type of business is usually very predictable with a large number of small exposures and can provide the retailer with a valuable additional source of revenue.

BVI insurers engaged in long term business are obliged by the Act to maintain segregated funds which are then only available to meet liabilities under policies in respect of which the segregated fund is maintained. Schemes can therefore be arranged, probably using an annuity policy, whereby assets in the fund are protected from other obligations, including judgements of a court. Professional tax advisers are generally involved in establishing such schemes.

There can be tax advantages to using a captive. The tax considerations in forming a captive will depend on the domicile of both the parent and the captive. Integration of a captive as part of an overall tax planning strategy is a complex subject, therefore, professional legal and tax advise is essential.

Captives come in all shapes and sizes and are owned by individuals as well as corporations. Although, clearly the formation of a captive is not for everyone, the scope of captives is much broader than is generally imagined and, in appropriate circumstances, a viable captive can be formed with a relatively small premium income.

The first step in establishing a captive is to commission a detailed feasibility study from professional advisers. The feasibility study should examine risk exposures, loss experience, the existing insurance program, expected future growth trends at the parent company and all matters which impact upon the decision as to how best to design vehicle for medium-term risk financing.

Any person carrying on insurance business in or from within the Territory must hold a valid insurance licence which is renewable annually. The licence may be for Long Term or General insurance or both. There are certain basic requirements to which all companies must adhere in applying for a licence and in conducting their on-going business:

• the company must appoint an authorised resident insurance manager and maintain a principal office in the BVI (usually at the insurance manager’s office)
• there must be no fewer than two directors and the company may not have a corporate body as a director
• the company may not issue bearer shares
• a detailed business plan must be presented with the application including projections for the first five years
• details of owners, directors, officers and professional advisers must be submitted together with appropriate references
• books and records are to be maintained in the Territory
• annual audited financial statements must be provided
• the company must be capitalised at least to the minimum level and must maintain a minimum on-going solvency margin.

Fees are due to the Government for company formation/licensing and for an insurance licence. Most captives are incorporated as IBCs and company fees are shown accordingly:

*includes first year’s annual fee.

Minimum paid in capital required is $200,000 for Long Term, $100,000 for General and $300,000 for both. Credit Life companies require capitalization of $10,000.

The minimum solvency margin for long term business is $250,000. For general business it is determined by reference to the amount of Net Retained Premium (NRP) as follows: