Formation and Operation of Offshore Insurance Companies
An offshore insurance company offers businesses and professionals an excellent way to turn a major money drain – insurance – into an income earning asset. Moores Rowland have been operating in Vanuatu since 1973 when the “offshore” Insurance legislation was first introduced.
Moores Rowland have incorporated and managed a vast and diverse group of captive insurance companies over a thirty year period. With the firm’s roots in the founding of the offshore center, the current partners have long standing experience in the establishment, administration and accounting for Offshore Captive insurance companies including reinsurance management, claims management, and funds management.
We offer a complete range of services to assist your company in setting up an insurance program that can provide major financial benefits to your company or to a group of companies that wish to join together in a cooperative venture.
How can you benefit from an offshore insurance company?
Public insurance companies have a huge infrastructure with an extensive physical infrastructure (buildings, computers, vehicles), major marketing costs, high paid executives and huge employee base, layers of seller commissions, monstrous legal costs, and heavy federal and state regulations. Your premiums to these companies pay for all of this plus their profit margin and – lastly – your insured risk.
Recent stock market losses plus giant pay-outs have contributed to the demise of several large insurance companies and the rest have raised premiums, reduced benefits, and have often become difficult in satisfying claims. To seek relief from escalating premiums, companies often accept high deductible insurance policies. This leaves them vulnerable to small claims which, in fact, are far more common than major claims. Regardless of these attempts to reduce what they pay in premiums, companies must pay more money each year to insurance companies. Although these premiums are tax deduct able, they are still a drain on the company profits and, of course, the company gets no investment value from the money after it is paid.
There is a highly cost-effective alternative you might wish to examine; setting up a Captive Insurance Company for self-insurance for minor risks and access to lower cost reinsurance in the commercial insurance underwriting market.
What is an Offshore Captive Insurance Company?
A offshore captive insurance company is a subsidiary company, wholly owned by a non-insurance company, that underwrites the insurable risks of its parent company or of its related or associated companies.
An Offshore Captive Insurance Company is a form of self-insurance where a company, group of companies or professionals, sets up an insurance company to self insure the normal or expected loss and to cover the potential catastrophic loss in the commercial insurance market by means of reinsurance. Captive insurance companies have direct access to commercial insurance underwriters and enjoy substantial discounts and credits often based on the company history rather than the industry standard.
Premiums for insurance cover is, in most countries, tax deductible irrespective of the nature of the insurance company. But self-insurance through the creation of – for example – savings or investment accounts within the corporate structure normally are not allowed for tax deductions until the funds are actually used to pay a claim. A captive insurance company transforms self insurance into a distinct corporate entity and thus permits tax deduction of premiums.
Kinds of Offshore Captive Insurance Companies
Captive insurance companies may be:
- pure captive – a company wholly owned by its parent and insuring only the risks of the parent.
- mutual captive – a company set up to insure the collective risks of members of mutual organizations such as medical professionals, trade or industry associations. Generally the membership must be limited to 10 members or less or it may be considered a public insurer.
- reciprocal captive – an association of separate entities who undertake self insurance on a collective basis under a general management structure. Mutual captives can expand their basic fund by working together under a general management structure.
- pure captive turned commercial underwriter or reinsurer – a pure captive entering the commercial insurance market by seeking business from external sources in addition to the core group.
Advantages of an Offshore Captive Insurance Company
In recent years, corporate groups with large insurable risks have found that the cost of insurance is a major overhead. Increased overhead, inflated pay-outs, and poor stock performance has made insurance companies escalate premiums and minimize services and conditions.
Standard premium levels are based on losses on an industry or group basis. Companies that spend more money and time lowering risks pay the same rate as companies that are careless. Also, standard policies force companies to insure risks that they might not, in fact, be exposed to or to risks that a company might only face in very rare instances.
A captive insurance company coupled with a reinsurance program offers greater cost reductions than inadequate premium credits of deductibles offered by conventional insurance.
Specific Cost Advantages
- Premium credits and commissions. Credits and commissions are set by the corporate group and to create lower premiums. The allowed credits and commissions remain in the captive insurance company.
- Investment of premiums. The corporate group through its captive insurance company holds the gross premium for reinsurance until the next premium is due and is able to generate investment income during the retention period.
- Timing of payments. The captive insurance company determines when the annual premiums should be paid and thus helps the group manage its cash flow, provided such payments meet the reinsurance premium requirements. For example if a company has an “off season” in cash flow, payments can be timed to a season when the company has the required surplus capital.
- Tax savings. Cash flow benefits also derive from the taxation advantages, with premiums being immediately tax deductible.
- Flexible investment policy. The funds held by the captive insurance company are under the control of the corporate group allowing them to manage a flexible policy of investment. This is especially useful if the Captive Insurance Company is set up in Vanuatu where its profits will not be taxed.
- Quick settlement of insurance claims. A captive insurance company will expedites quick settlement of insurance claims.
Where should the Captive Insurance Company be located?
Locating the Captive Insurance Company in an offshore location depends on:
- Legislative restrictions
- Exchange control and investment flexibility
Regulations governing the operations of insurance companies in most major countries are designed for insurance companies soliciting business from the general public. This means the captive would be subject to the strict legislative requirements to maintain the same standards as a major commercial insurance company for:
- Minimum capital levels.
- Solvency tests and minimum reserve levels.
- Stringent reporting procedure.
- Public disclosure of financial statements.
- Investment of reserve funds.
Creation of a captive insurance company in Vanuatu dealing exclusively with foreign clients is a relatively simple exercise and the captive is not required to meet legislative controls for local insurance companies that deal with the public.
One of the advantages of a captive insurance company is the generation of cash flow benefits to the corporate group through the deferment or reduction of tax liabilities. Payment of insurance premiums to a captive insurance company will generally be tax deductible to the insured group members.
If the captive insurance company is in a taxable jurisdiction, the gross premium received will be taxable although deductions can be made for reinsurance premiums and overhead expenditure. A deferment of tax liability may also be possible if the captive insurance company carries forward the premiums received as unearned income at balance date. However, these are only deferments of tax liabilities.
If the captive insurance company is based in Vanuatu the net premium income of the Captive Insurance Company will be free from taxation other than any withholding taxes imposed by the corporate group’s home country.
The corporate group therefore obtains a tax deduction against its domestic income for the premiums paid but pays little or no tax upon the retention of the net premium by Vanuatu captive insurance company.
Investment income derived by the captive insurance company is also taxable in a domestic Captive Insurance Company, usually at full corporate tax rates, although dividend income is often reduced with rebates, credits or exemptions. Many tax jurisdictions also levy corporate income tax on insurance companies that sell investments. This would be taxed as capital gains for other companies but the tax offices argue that the acquisition and disposal of investments are normal business activities of an insurance company.
The investment income derived within Vanuatu by the captive insurance company will be free from taxation. However, if the reserve funds of the Vanuatu captive insurance company have been invested within a country which imposes taxation, withholding taxes may be payable on the income derived from such investments.
Vanuatu based captive insurance companies will pay little or no tax on their total income, thereby enabling reserves to be accumulated at a much greater rate than would be possible for domestic captive insurance companies. This permits Vanuatu captive insurance companies to gradually increase the assumption of risk and reduce premiums on reinsurance.
Exchange Control and Investment Flexibility
A captive insurance company in Vanuatu transforms an insurance cost into a profitable corporate subsidiary. Accumulated net premium funds held by the captive insurance company, under the control of the corporate group, offer a flexible investment policy for prudent investment.
This is often not possible for domestic captive insurance companies because of legislative requirements controlling the investment of accumulated funds. Many countries also restrict investments through local exchange control regulations, thus reducing the potential of an international investment portfolio.
Vanuatu does not have controls over the investment of capital and reserve funds of captive insurance companies nor do currency or exchange controls inhibit international investments.
A Vanuatu based captive insurance company offers the following principal advantages over a domestic captive insurance company:
- It can accumulate reserves at a faster rate because it is not taxed on net premium and investment income.
- It is free from exchange controls.
- It can maintain complete flexibility in its investment policy.
- The absence of government interference.
Operation of a Vanuatu Captive Insurance Company
Incorporation of insurance companies in Vanuatu requires application for a permit to incorporate together with an application for an insurance licence. The Vanuatu government requires disclosure of basic details relating to the promoters of insurance companies. Provided the promoters do not have a criminal record or other dubious commercial background, approval is usually routine. The application is a confidential document and, for an exempted insurance company, subject to the secrecy provisions of Vanuatu legislation.
The management of the captive insurance company requires:
- Risk management, involving both the technical and actuarial evaluation of risk areas and the formulation of a self insurance program. This function must be conducted on a regular basis to ensure constant review of loss potential.
- Establishing a reinsurance program including determination of retention levels and stop loss limits.
- Placement of reinsurance and negotiation of reinsurance treaties.
- Fronting arrangements
- Claims management including the evaluation, adjustment and settlement of claims between the captive and both the insurer and the insured corporate group member.
- Administration including the completion of documentation, statutory corporate requirements and legal services.
- Fund management involving the investment of capital, reserves and accumulated funds.
These functions must be carried out by the Vanuatu captive insurance company and not by the corporate group in its local jurisdiction, although obviously close co-operation is essential.
The Vanuatu captive insurance company can either employ its own permanent staff to provide the required management services or it can engage the services of a professional insurance management firm.
Most companies choose the latter alternative which keeps management on an arm’s length basis and provides a ready means of identifying the costs of the captive insurance company. The engagement of local management in Vanuatu also avoids potential complications with tax authorities in the domestic jurisdiction.
The captive insurance company should not employ staff of its parent or domestic associate company in its day to day operations as this could constitute the carrying on of business through a branch in the domestic location. This situation would be confirmed if any such person had authority to contractually bind the captive, as he could be deemed to be the permanent establishment of the captive insurance company within the domestic jurisdiction. As such, the captive insurance company would become liable to taxation in that jurisdiction.
The captive insurance company must operate and be managed on a basis consistent with conventional insurance companies. Reinsurers will require that risks be evaluated on a realistic basis and that premiums be determined accordingly. Similarly, they will require proper commercial procedures in evaluating and settling claims made by group members.
At all times the captive should be regarded as a viable insurance entity – a way to reduce insurance costs and not a means of tax minimization.
Types of Insurable Risk
The captive insurance company may insure almost any form of insurable risk, however the most common types of insurance cover effected through captives are:
- Product liability coverage
- General property and casualty coverage
- Medical malpractice liability
- Workers compensation
- General property (usually minor claims)
- Loss of profits
- Marine-cargo and hulls
- Employee benefits
- Group pension plans
- Products recall
- Product liability
- Pollution liability
- Expropriation of assets
- Nuclear explosion
- Currency devaluation
One of the primary functions of a captive insurance company is to reduce the overall cost of insurance without disproportionately increasing the loss potential. Cost reductions achieved by a more realistic assessment of premium levels, reinsurance credits and commissions, and taxation savings must be offset against operating costs. The lower the operating costs, the greater the cost reductions and potential earnings of the company.
Investment of Funds
The investment of capital, reserves and accumulated premium and investment income is critical to the success of a captive insurance company. These are the funds which will cover the self-insured portion of potential losses. Vanuatu captive insurance companies must take advantage of their flexibility in investment policy for prudent and sound long term benefits.