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Onshore vs. Offshore Domicile selection is first step in setting up a captive By Michael J. Moody, MBA, ARM The selection of a captive’s domicile is one of the most important decisions involved in a captive feasibility study. And the first critical question that needs to be resolved is “onshore or offshore?” This is such an important issue that it needs to be resolved before any of the other issues are addressed since all financial and operational assumptions are dependent on the domicile chosen. For the most part, the captive movement began in Bermuda. And historically, captive insurance companies have been associated with various offshore venues. In addition to Bermuda, the Cayman Islands and Barbados were early adopters of legislation conducive to captive insurance company formations. Today, there are more than 5,500 captives worldwide. And those numbers have steadily increased since 1980, when there were only about 1,000 captives worldwide. However, the same question still applies: “onshore or offshore?” Offshore domiciles There are, of course, numbers of reasons why a potential captive owner chooses an offshore domicile over an onshore one. However, among the primary reasons noted by many captive owners is the major advantage that relates to legislative requirements which typically are far less onerous than those of onshore competitors when it comes to the margin of solvency and initial capitalization. Other advantages include flexibility, ease and speed of entry, established infrastructure, cost savings and potential tax advantages. Offshore domiciles are typically synonymous with increased flexibility; however, sometimes today this is more a perception than reality. Flexibility usually arises in terms of the ownership structure, operations, allowable investments and, of course, capitalization. In addition, most of the tax benefits that fueled offshore captive formation in the early days of the captive movement have either been greatly reduced or eliminated. Despite this, some tax advantages still exist and should be considered in any captive feasibility study. Bermuda continues to maintain its number one position in the worldwide captive market. In addition, the Cayman Islands, British Virgin Islands and Barbados are also viable and active offshore domiciles. Another major offshore domicile that has gained significant attention is Ireland. Since the European Union was established, Ireland has become a favorite domicile because it can write risk direct in other EU countries. Onshore domiciles Today, however, offshore domiciles are not the only game in town and onshore domiciles led by Vermont, are growing significantly. Among the reasons noted by captive owners are: • Tax differences are less significant and after recent new international regulations, most domiciles can no longer be considered offshore tax havens. • Many onshore domiciles are becoming equally flexible and creative. • The cost to operate an offshore captive is increasing, both from a monetary and time standpoint. The past few years have seen a rush of new captive domiciles in the United States. Today, more than 30 states have enacted some form of captive legislation and every month or two, another state joins the battle for captive insurance company business. All of this competition has generally been beneficial to captives in providing a wide range of domicile options. While the range of locations has expanded, there are questions as to the ability to continue to find capable personnel at the regulatory level to properly monitor the captive’s activities. Quick comparison A recent study by the Aon Corporation titled “Aon’s Global 1500: A Captive Insight” can provide some current data on this subject. The Aon study surveyed the 1,500 largest corporations worldwide to determine the companies’ approach to captives. Aon noted that there has been a steady growth in the captive market over the past 20-plus years, suggesting that the state of the insurance market no longer plays a significant role in deciding to form a captive. The study goes on to note that “the hard or soft state of the market does not result in a surge, or decline, in captive formations for that period.” The Aon study also confirms that United States corporations continue to favor Bermuda. Second, they tend to look to Vermont as an onshore domicile. In fact, those two locations account for about 75% of all the United States parented captives. However, over the past 10 years the dynamics have changed somewhat. Recent years have shown a growing trend towards the use of onshore domiciles. There have been several critical changes in the United States and elsewhere that have impacted on the domicile selection for captive insurance companies. High on this list has been the effect of and the fallout from the events of 9/11. Nowhere is this more evident than in the external international regulatory bodies and how they influence the business of offshore financial centers. This increasing influence is occurring in several key ways: anti-money laundering legislation, increased captive regulations and taxation. Among the most active regulatory authorities have been the International Monetary Fund (IMF), the International Association of Insurance Supervisors and the Financial Action Task Force. An additional legislative effort has been the enactment of the Patriot Act which requires significant monitoring of any activities that relate to the United States federal government’s terrorist lists. While there is still a great interest in strengthening the international captive laws and regulations, the main attention has been directed at combating money laundering. And while some of these actions affect all captive domiciles, they have been the hardest on offshore domiciles since most have had to develop and implement stringent oversight regimes. This would typically include provisions for a more rigorous licensing process, a strong anti-money laundering procedure, timely reporting requirements and numerous sanctions. Despite these numerous positive developments, some potential captive owners still believe that most offshore domiciles are poorly regulated “tax havens.” One of the consequences of all this additional monitoring and oversight has been to increase the cost of some third-party captive services and government fees. Back to basics So, at the end of the day, the more things change, the more they remain the same. The selection of a captive domicile still is a very company-specific determination based on the individual needs and requirements of the captive parent. Each situation will be unique and a detailed analysis will be required of each potential captive. Captive feasibility studies will need to include any and all variables that could affect the outcome of the study. As the latest information from the Aon 1500 study shows, the onshore/offshore formations are becoming closer and closer. And they are projected to be about neck and neck by 2010. But some things will remain the same. For some time now, Bermuda has been at the forefront of the captive movement. Last year, Bermuda saw a 10% increase in insurance/reinsurance company incorporations. A total of 82 new insurance/reinsurance operations was established in 2006—a number that any domicile would be proud of. Significantly, the majority of these new formations was large, highly capitalized reinsurers. However, captives also made up a significant portion of the new incorporations as well, but it is clear that Bermuda is working hard to further brand itself as the World’s Risk Capital. Bermuda has become an innovative insurance center that has provided critical capacity when the world insurance markets require it, but not without some downside for captives. Is Bermuda in danger of losing its top captive domicile billing? Not likely. But anyone who follows the captive movement can see what is on the horizon for captives in Bermuda. If you follow the current trends in Bermuda to their natural conclusion, you will realize that at some point, many service providers (i.e., actuaries, lawyers, auditors, captive managers, etc.), all of which are in short supply, will price themselves out of the captive market. The service providers for other offshore domiciles as well as those on shore will simply provide a more cost-effective alternative. Conclusion Without question the onshore domiciles have been gaining market share at the expense of the offshore locations. However, since the overall market for captives continues to grow, this still represents a win/win situation. An even bigger issue for the onshore domiciles today is the increased competition from other states that are throwing their hats into the captive domiciliary ring. So long as the captive movement continues to advance, all boats will float at higher levels. And according to the Aon 1500 study, there is plenty of growth potential left for the captive movement. The study indicates that the captive market remains underdeveloped with slightly over half (53%) of the global 1500 companies without a captive insurance subsidiary. Aon notes that these companies are failing to achieve a better quality of coverage as well as cost savings that range from 10% to 15% which are derived from economies of scale, leverage and the efficient use of capital. Based on these findings, the captive movement’s future is so bright, “they are going to need shades.” * |
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