Title Slide. Second Header

Transcription

1 Title Slide Second Header

2 Moderator Roger Gillett Why Companies Form Captives Phil Barnes Captive Tax Update Rick Irvine Latest Ideas In Captive Use Scott Gemmell How To Form A Bermuda Captive Neil Horner Why Bermuda Phil Barnes

3 Title Slide Second Header

4 Why Form a Captive Philip Barnes Aon

5 Philip Barnes Managing Director Aon Insurance Managers (Bermuda) Ltd. BIMA Exec Committee (immediate past president) Member IAC Board member ICCIE 24 years captive experience

6 WHAT IS A CAPTIVE? Insurance subsidiary of a commercial/financial company, or a consortium or an association of individuals Formed to primarily insure, or reinsure the risks of its parent, or of a number of parties with risks in common or unrelated risk Usually formed in a specialized environment or domicile onshore or offshore

7 TYPES OF CAPTIVE Single Owner Multi-owner or Association Rent-a-Captive multiple non-owner Protected or Segregated Cell Captive (PCC, SPC, SAC) any of the above

8 WHY FORM A CAPTIVE? 1. Information and Control 2. Risk Management Focus 3. Additional Capacity 4. Direct Market Access 5. Flexibility in Program Design 6. Uninsurable Risk 7. Financial Stabilizing 8. Profit Centre

9 1. INFORMATION and CONTROL Influence program design and cost through progressive retentions Reliable data for reinsurance purposes May assist with rating requirements Access to loss data / reserving practice Claims handling control image preservation, avoidance of legal precedents, out-of-court settlement, negative publicity management, damage limitation

10 2. RISK MANAGEMENT FOCUS As a separate subsidiary of the business, focuses senior management attention on risk Risk manager can use risk management ranking methods to influence premium allocation to business units / divisions Use captive surplus to fund risk improvements Ring-fence risk funding Use contributions to fund loss control projects

11 3. ADDITIONAL CAPACITY Can act as a direct insurer (where permitted) Can act as a reinsurer behind a fronting company Provides insurance coverage throughout fluctuating insurance cycles = price stabilization Reduces the dependency for obtaining risk transfer through commercial markets. Strategic layer completion e.g. left with a gap unable to complete property layer at lead underwriter premium Captive used to write the gap at lead underwriter premium thereby completing the layer Captive purchased reinsurance at a higher premium, but integrity of pricing for the rest of the layer was maintained Saved the increase layer pricing for the benefit of the insured

12 4. DIRECT MARKET ACCESS Allows direct access to reinsurance markets & ART markets Wholesale market cheaper than direct markets Reinsurance markets less regulated, wider range of solutions - better program design May reduce / eliminate brokerage fees Collection of reinsurance commissions

13 5. FLEXIBILITY IN PROGRAM DESIGN Acts as a negotiating tool in coverage and pricing with markets Allows for customized covers, broader wordings, manuscript policy forms Coordination of insurance programs throughout multiple jurisdictions: (DIC/DIL covers, global programs)

14 6. UNISURABLE RISK Such exposures carried on balance sheet Create capacity above captive retention Can become tax-deductible premium expense Transfer liability off balance sheet Turn a cost center into a potential profit center e.g. gradual environmental pollution

15 7. FINANCIAL STABILIZING Insulates owner from withdrawal of capacity by conventional markets: pollution, asbestos, flood, windstorm, terrorism. Uses its capacity and reservoir of earnings to stabilize premiums during harder markets Allows access to multi-year ART programs to spread losses across time Dividend release can be harmonized with parent s capital needs to reduced debt/equity ratios, tax loss offset.

16 8. PROFIT CENTRE Offensive not defensive use Attract related third party business, e.g. customer insurance programs Diversify risk in captive One corporate vehicle to measure risk management performance

17 Title Slide Second Header

18 CAPTIVE INSURANCE COMPANY TAX UPDATE Richard E. Irvine Partner PricewaterhouseCoopers

19 Captive Insurance Companies History of Federal Taxation of Captives FAS 5 Standard for accruing liabilities Estimable and Probable Standard US Tax Standard for deducting accrued liabilities under IRC 461 Economic Performance Standard Liability must be fixed and determinable Economic performance occurs w/in 8 ½ months (i.e., payment) restrict deductibility to cash method US Insurance Company Taxation (Subchapter L): May establish (i.e., deduct) a reserve which is fair and reasonable May earn certain revenues over period of obligation (Extended Service Contracts) The contractual shifting of risks to a qualified captive establishes US GAAP/Tax parity Result Balance Sheet Monetization

20 Captive Insurance Companies History of Federal Taxation of Captives 1941 No statutory or regulatory definition of insurance, but U.S. Supreme Court said, for tax purposes, insurance must include: Insurance Risk Risk Shifting Risk Distribution Common notions of insurance Helvering v. LeGierse, 312 U.S. 531 (1941) 1977 IRS issues Revenue Ruling , which concluded no insurance among related parties because you cannot have RISK SHIFTING within an economic family Series of court cases denying captive benefits which focused on Risk Shifting Carnation v. Commissioner, 71 T.C. 400 (1978), 640 F.2d 1010; 1981 Parental Guaranty Clougherty Packing v. Commissioner, 84 T.C. No. 61 (1985), 811 F.2d 1297; 1987 First application of the Balance Sheet Theory

21 Captive Insurance Companies History of Federal Taxation of Captives Series of court cases denying captive benefits (Continued) Gulf Oil Corporation v. Commissioner, 89 T.C (1987), 914 F.2d 396; % unrelated risk insufficient Mobil Oil, Stearns-Rogers, Beech Aircraft 1989 Revenue Ruling No amount of unrelated risks will enable risk shifting

22 Captive Insurance Companies History of Federal Taxation of Captives 1989 Taxpayer wins in Humana in the 6th Circuit Court of Appeals Balance Sheet Theory applied (Brother/Sister distinguished from Parent/Subsidiary) Taxpayer wins in AMERCO, Harper, Sears and ODECO based upon significant levels of unrelated risk Technical risk shifting Risk shifting in substance (e.g., risk is shifted into the pool of unrelated risk premiums) 1993 IRS issues Revenue Rulings and Ruling which conclude that employee benefit risks are unrelated risks 1997 Taxpayer wins in HCA and Kidde (opens brother/sister captive to all Circuits 1999 Tax Analyst files FOIA request to have access to Field Service Advices. Review of FSA s indicate IRS has been conceding captive cases since 1993

23 Captive Insurance Companies History of Federal Taxation of Captives 2001 IRS issues Revenue Ruling and obsoletes all prior captive rulings dealing with economic family will still pursue captive issue on facts and circumstances will look for thinly capitalized captives and presence of parental guarantees and hold harmless agreements 2002 Revenue Procedure IRS will now rule on captive insurance transactions (formerly a no rule area) and IRS Issues Revenue Rulings affirming insurance tax treatment

24 Captive Insurance Companies History of Federal Taxation of Captives 2002 Revenue Ruling Premium payments from parent and from subsidiaries are deductible provided: Third party premium constitutes 50% or more of total premium, Risks are homogeneous Common notions of insurance are satisfied No loanbacks Premium payments from parent are not deductible when: Third party premium constitutes 10% or less of the total premium Revenue Ruling brother/sister subsidiaries insure professional liability risks with captive 12 or more insured subsidiaries No insured accounts for less than 5% or more than 15% of total risk insured by captive Homogeneous risks Captive licensed in each state it does business No loanbacks

25 Captive Insurance Companies History of Federal Taxation of Captives Revenue Ruling group captive insures professional liability risks of its shareholders Number of insureds is not disclosed; however, no insured accounts for less than 5% or more than 15% of total risk insured by captive (implies 7 or more owners) Homogeneous risks Captive licensed in each state it does business No loanbacks

26 Captive Insurance Companies History of Federal Taxation of Captives 2004 Pension Funding Equity Act of 2004 Clarifies definition of insurance company for non-life insurance company purposes More than half of the business during the year is the issuance of insurance, reinsurance or annuity contracts Changes qualification standard for tax exempt status under IRC Section 501(c)(15) $600,000 gross receipts limitation 50% or more must be (re)insurance premiums Changes the qualification standard for small insurance companies under IRC Section 831(b) $0 - $1,200,000 premium limitation

27 Captive Insurance Companies History of Federal Taxation of Captives 2005 Revenue Ruling IRS sets forth its position on risk distribution Examined 4 Situations Single Unrelated Insured = not sufficient risk distribution Two Unrelated Insureds (90/10 concentration) = not sufficient risk distribution 12 LLC s (disregarded entities) = SMLLC s are not viewed as separate entities so a single insured, no risk distribution 12 LLC s elect to be treated as associations (check the box) = multiple insureds, adequate risk distribution

28 2005 IRS Notice Captive Insurance Companies History of Federal Taxation of Captives IRS requested comments to develop additional guidance in the captive taxation area Specifically, the Service requested input regarding What factors should be taken into account in determining whether a cell captive arrangement constitutes insurance and if so, the mechanics of federal elections (i.e., IRC Sections 953(d) and 953(c)(3)(C)) Affect of loanbacks of premiums on a related party insurance arrangement Relevance of homogeneity on whether risks are adequately distributed Issues raised by finite risk transactions

29 Captive Insurance Companies Recent Activity PLR The IRS ruled that an organization did not qualify for tax-exempt status under section 501(c)(15) because its insurance arrangement had no risk distribution. Taxpayer's sole shareholder is X, a corporation that contracts with physicians and other medical service providers, as independent contractors. Taxpayer has no employees and issued one purported insurance contract each in 2002 and 2003, identifying X as the "Name Insured" and several other parties as "Insureds." The other Insureds included approximately 30 physicians. For each relevant policy year, the premium was paid by X on behalf of all the insureds. The IRS reasoned that even though there were purportedly multiple insureds under the policy, the only risks insured were those that arose in connection with providing medical services to Named Insureds' own clients. As such, it appeared likely that a claim against any Insured would necessarily entail a claim against the Named Insured as well.

30 2006 Proposed Regulations under (e)(2) Captive Insurance Companies Recent Activity Involved the treatment of insurance transactions involving obligations between members of a consolidated group Under current regulations ( (e)(2)(ii)(A)), if a member provides insurance to another member in an intercompany transaction, the transaction is taken into account on a separate entity basis Under the proposed regulations, where a significant portion (5% or more) of the business of the insuring member arises from insuring other members, the Service deemed it appropriate to take the items in the transaction into account on a single entity basis The proposed regulations had the effect of eliminating the tax benefits associated with captive insurance transactions in a consolidated group, which have been provided for by the courts in a number of captive insurance cases arguing against the Service s economic family theory. On February 20, 2008, the IRS withdrew the portion of the proposed regulations relating to the treatment of transactions involving the provision of insurance between members of a consolidated group, in response to the comments received According to the IRS, it will continue to study whether revisions to the rules of intercompany transactions are necessary to clearly reflect the taxable income of consolidated groups.

31 Captive Insurance Companies Recent Activity Revenue Ruling X, a domestic accrual method corporation, was engaged in a business process that was inherently harmful to people and property. As a result, government regulations required X to remediate the harm, requiring X to incur future costs in order to restore X s business location to its condition before X s business began. The exact amount and timing of the future costs were a function of many unknown factors; however, there was no uncertainty that the future costs would be incurred. X estimated the present value of the future costs ($150x) and entered into an arrangement with an unrelated insurance company (IC) to reimburse X for its future costs, up to a limit of $300x. The IRS concluded that the arrangement lacked the requisite insurance risk to constitute insurance. There was certainty that IC would have to perform under the arrangement, so the arrangement was pre-funding by X of its future obligations. The central theme is that an arrangement that lacks fortuity fails to qualify as insurance for tax purposes.

32 Captive Insurance Companies Recent Activity PLR Group captive ruling where an undisclosed number of companies in a group captive insure homogeneous risks. The Taxpayer requests a ruling not to be taxed as an insurance company under IRC Section 831(c) Service applies Revenue Ruling IRS notes that each participating entity is in significant part paying for its own risks Notes that several members constitute > 15% of the risks insured by the captive There is not adequate risk distribution because there are too few members (less than the number implied in Revenue Ruling ) because several members constitute > 15% of the risks. Service concludes a lack of risk distribution and no insurance.

33 Captive Insurance Companies Recent Activity Final Regulations under (c)(2)--Domestic nonlife insurance companies. Every domestic insurance company other than a life insurance company shall make a return on Form 1120-PC, "U.S. Property and Casualty Insurance Company Income Tax Return." This includes organizations described in section 501(m)(1) that provide commercial-type insurance and organizations described in section 833. Except as provided in paragraph (c)(4) of this section, such company shall file with its return a copy of its annual statement (or a pro forma annual statement), including the underwriting and investment exhibit (or any successor thereto) for the year covered by such return (c)(4)--Exception for insurance companies filing their Federal income tax returns electronically. If an insurance company described in paragraph (c)(1), (c)(2), or (c)(3) of this section files its Federal income tax return electronically, it should not include on or with such return its annual statement (or pro forma annual statement), or any portion thereof. Such statement must be available at all times for inspection by authorized Internal Revenue Service officers or employees and retained for so long as such statements may be material in the administration of any internal revenue law. See (e).

34 Final Regulations under (c)(5) -- Definition. Captive Insurance Companies Recent Activity For purposes of this section, the term annual statement means the annual statement, the form of which is approved by the National Association of Insurance Commissioners (NAIC), which is filed by an insurance company for the year with the insurance departments of States, Territories, and the District of Columbia. The term annual statement also includes a pro forma annual statement if the insurance company is not required to file the NAIC annual statement (k) Effective/applicability date. Paragraph (c) of this section applies to any taxable year beginning on or after May 30, However, taxpayers may apply paragraph (c) of this section to any original Federal income tax return (including any amended return filed on or before the due date (including extensions) of such original return) timely filed on or after May 30, For taxable years beginning before May 30, 2006, see as contained in 26 CFR part 1 in effect on April 1, IRS acknowledges that "pro forma" is not defined, and advises to prepare financial statements that provide sufficient information for the Service to understand a company's activities. For example: Vintaging of loss reserves Schedule F type reinsurance detail

35 Captive Insurance Companies Recent Activity FAA F Example of the IRS applying FAS 113 criteria IRS Counsel gave advice to revenue agent that transaction did not meet tax criteria for insurance risk where A (the ceding company) and B (the assuming company) entered into a retroactive insurance contract in Year 1. The contract ceded 90% of A's losses to multiple assuming companies. B assumed 30%, A retained 10%, Remaining 60% was assumed by other insurers. Losses subject to the contract included loss and loss adjustment expenses paid by A on or after Year 1 for accident years prior to Year 1. Transaction met risk transfer criteria for both GAAP (FAS 113) and Stat (SSAP 62) IRS counsel ultimately found that no insurance risk had transferred when the tax savings were included in the analysis, and therefore sufficient insurance risk was not present.

36 Captive Insurance Companies Recent Activity Revenue Ruling The IRS provided guidance through examples of when a cell of a protected cell company can enter into a transaction which is treated as insurance for federal income tax purposes, and when amounts paid to these cells is deductible as insurance premiums under Section 162. Example 1: X, a corporation that owns Cell X, enters into a contract whereby Cell X insures professional liability risks of X. Cell X does not enter into any arrangements with entities other than X. IRS finds the arrangement between X and Cell X is akin to a parent and its wholly owned subsidiary, and in the absence of unrelated risk, lacks the requisite risk shifting and risk distribution to constitute insurance. Example 2: Y, a corporation, owns all stock of Cell Y, as well as all the stock of 12 subsidiaries. (Mirrors facts of Rev. Rul ). The 12 subs have a significant volume of independent, homogenous risks, insured into Cell Y. No sub has coverage for less than 5% nor more than 15% of the total risk insured by Cell Y. IRS finds the subsidiaries have shifted the liability risks to Cell Y. The premiums are pooled such that a loss by one sub is not in substantial part paid from its own premiums. Had the subs of Y entered into identical arrangements with a sibling corporation that was regulated as an insurance company, the arrangements would constitute insurance and the premiums would be deductible under Section 162.

37 Captive Insurance Companies Recent Activity IRS Notice In conjunction with Revenue Ruling , the IRS issued the Notice to request comments on further guidance to address issues that arise if those arrangements do constitute insurance, specifically, the status of such a cell as an insurance company within the meaning of 816(a) and 831(c), and some of the consequences of a cell s status as an insurance company. The Notice puts forth proposed guidance that would address (a) when a cell of a Protected Cell Company is treated as an insurance company for federal income tax purposes, and (b) some of the consequences of the treatment of a cell as an insurance company. The proposed guidance would include a rule to the effect that a cell of a Protected Cell Company would be treated as an insurance company separate from any other entity if: the assets and liabilities of the cell are segregated from the assets and liabilities of any other cells and from the assets and liabilities of the Protected Cell Company based on all the facts and circumstances, the arrangements and other activities of the cell, if conducted by a corporation, would result in its being classified as an insurance company within the meaning of 816(a) or 831(c).

38 Captive Insurance Companies Recent Activity IRS Notice Effect of insurance company treatment at the cell level under the proposed rule: Any tax elections that are available by reason of a cell s status as an insurance company would be made by the cell; The cell would be required to receive an employer identification number (EIN) if it is subject to U.S. tax jurisdiction; The activities of the cell would be disregarded for purposes of determining the status of the Protected Cell Company as an insurance company for federal income tax purposes; The cell would be required to file all applicable federal income tax returns and pay all required taxes with respect to its income; and A Protected Cell Company would not take into account any items of income, deduction, reserve or credit with respect to any cell that is treated as an insurance company under the proposed rule making

39 Captive Insurance Companies Recent Activity PLR IRS revoked the tax-exempt status of a Section 501(c)(15) because it was overcapitalized and did not meet the operational requirements of an insurance company. Corporation was formed to write mortgage guarantee reinsurance and other classes of insurance and reinsurance to its parent and affiliates. When corporation was created, it generated minimal investment income; however, as a result of reorganization, corporation was the recipient of additional paid in capital in the form of shares of stock. Stock had a significant FMV and generated dividend and interest income Corp received 88.6% of the gross income from interest and dividends and only earned 11.4% of its combined total revenue from insurance premiums.

40 Captive Insurance Companies Recent Activity In revoking the entity's tax-exempt status the IRS raised the following questions about the organizations' status as an insurance company: Whether the organization is an insurance company exempt from tax pursuant to Section 501(c)(15) for the relevant taxable years?, Whether the organization continues to qualify for exemption from federal income tax as an organization described in Section 501(c)(15)?, Can the organization Rely on the Determination Letter Granted by the IRS Pursuant to IRC Section 501(c)(15)?, and Is the entity entitled to relief pursuant to IRC Section 7805(b)?

41 Captive Insurance Companies Recent Activity Revenue Ruling Describes the insurance excise tax consequences (under section 4371) of insurance premiums paid by one foreign insurer (foreign insurer) to another (foreign reinsurer). The ruling describes 4 fact patterns: Situation 1 --Foreign insurer, incorporated in X, insures U.S. risk. There is no tax treaty between U.S. and X. Foreign insurer reinsures with foreign reinsurer in country Y. There is a tax treaty between U.S. and Y that does not exempt insurance from excise tax. Premiums paid by U.S. corporation are subject to 4% excise tax Premiums paid by foreign insurer to foreign reinsurer are subject to 1% excise tax.

42 Captive Insurance Companies Recent Activity Revenue Ruling Situation 2 --Foreign reinsurer, incorporated in country W, reinsures U.S. insurer. Foreign reinsurer enters into reinsurance agreement with foreign reinsurer, incorporated in country Y. Both W and Y have tax treaties with U.S. that do not exempt insurance from excise tax. Premiums paid by U.S. insurer to foreign reinsurer are subject to 1% excise tax. Premiums paid by Foreign reinsurer to other foreign reinsurer are subject to 1% excise tax. Situation 3 --Same facts as #1, except that there is a tax treaty between X and U.S that exempts insurance from excise tax as long as it is not reinsured with an entity not entitled to the benefits of the treaty. Premiums paid by U.S. corporation would be exempt from excise tax; however are subject to 4% excise tax as of the date the reinsurance premiums are paid by foreign insurer to foreign reinsurer. Premiums paid by foreign insurer to foreign reinsurer are subject to 1% excise tax.

43 Captive Insurance Companies Recent Activity Revenue Ruling Situation 4 --Same facts as #1, except that foreign insurer is resident of country Z, and there is a tax treaty between Z and U.S. which exempts insurance from excise tax, as long as the policies are not part of a conduit arrangement. Premiums paid by U.S. corporation to foreign insurer are exempt from excise tax. Premiums paid by foreign insurer to foreign reinsurer are subject to 1% excise tax.

44 Captive Insurance Companies Recent Activity Announcement Voluntary compliance initiative Allows foreign insurance companies who have failed to pay excise tax due under section 4371, or failed to disclose that it had claimed a waiver from the taxes pursuant to an income tax treaty, to become compliant with its obligations. In general, if a taxpayer participates in this initiative in accordance with the terms laid out in this announcement, the IRS will not conduct examinations covering insurance excise tax liabilities arising under the four situations set forth in Rev. Rul , or any similar fact pattern, to the extent that premiums are paid or received by the participating taxpayer during any quarterly tax period prior to October 1, Does not cover foreign (re)insurers previously subject to a Closing Agreement with the IRS.

45 Captive Insurance Companies Recent Activity TAM Addressed whether an entity classified as a partnership for federal income tax purposes should be considered the insured entity under a purported insurance arrangement for purposes of evaluating whether there is sufficient risk distribution to treat the arrangement as insurance for federal income tax purposes The Service concluded that a general partnership, where the general partner(s) are ultimately liable for the liabilities of the entity, it is the general partner whose risk of loss is shifted; as such, it is the general partner who should be considered the insured The Service concluded that an entity treated as a partnership which is of the type that does not have a general partner(s); that is, under applicable law no liability of the entity can in the ordinary course attach to anyone other than the entity, it is the entity that should be considered the insured.

46 Captive Insurance Companies Recent Activity TAM IRS addressed whether a manufacturer s warranty constituted insurance for federal income tax purposes Taxpayer offered products at retail which were covered by either a manufacturer s warranty or by a warranty offered by the retailer. Taxpayer purchased manufactured goods on a warranty released basis but retained recourse against the manufacturer if default rates exceeded specified levels. Taxpayer purchased insurance coverage from a related insurance company under a deductible reimbursement policy. The Service concluded that the insurance of a manufacturer s warranty should not be considered insurance for federal tax purposes because it is more akin to a service contract and there was no fortuity in the losses incurred under the warranty since the manufacturer should be able to control the level of losses from manufactured goods. The Service distinguished the manufacturer s warranty from an extended warranty (which have been found to be insurance) based upon what was deemed covered under the UCC.

47 Title Slide Second Header

48 LATEST IDEAS IN CAPTIVE USE Scott Gemmell Vice President Marsh

49 Current Environment Latest Ideas in Captive Use Captive market remains strong despite soft commercial market Significant interest/feasibility studies Diverse reasons for captive formations Risk management driven Economic situation requires more strategic use

50 Latest Ideas in Captive Use Most Common Uses Global - Business underwritten by Captives (source: Marsh sample group) Other 15% Auto Liability 9% Employer's Liability/WC 12% Financial Products 6% Property Damage 20% Professional Indemnity 8% Product Liability 4% Marine 4% Health/Medical 4% General/Third Party Liability 18%

51 Latest Ideas in Captive Use Insurance Cyber Risk Product Contamination/Product Recall Customer/Supplier Risk Employee Benefits (International/Domestic)

52 Latest Ideas in Captive Use Risk Management Insurance Class Underwritten by Captive Example Risk Management Initiatives Property Damage Business Interruption Workers Compensation Auto Liability/Auto Damage Property Risk Evaluation Fire Protection System Installations Business Continuity Planning Business Impact Analysis Studies Health and Safety Training Behavioural Risk Improvement Driver Safety Programs Fleet Risk Management Technologies

53 Latest Ideas in Captive Use Program Design Three key issues: Understand the capacity and appetite to assume more risk Determine future expected losses Gauge market response Consider the TCOR

54 Latest Ideas in Captive Use Investments Factoring on Receivables Mortgages Ownership of Corporate Assets Investment in Commercial Paper

55 Latest Ideas in Captive Use Conclusion Captives as a strategic risk financing tool are continuing to evolve and deliver benefits to the parent company in many areas, not just insurance or tax.

56 Title Slide Second Header

57 HOW TO FORM A BERMUDA CAPTIVE Neil Horner Senior Counsel Attride-Stirling & Woloniecki

58 How to form a Bermuda captive Formation of a Bermuda captive insurance company involves two separate processes First process is registration as a company under the Bermuda Companies Act 1981 ( Companies Act ) Typically captive incorporated as an exempted company, meaning that non-bermudians can own 100% of the share capital Second process is licensing of the company under the Bermuda Insurance Act 1978 and its related regulations ( Insurance Act ) Insurance company will pay annual government fee on its assessable capital and an initial registration fee under the Insurance Act and an annual business fee thereafter

59 Companies Act registration Incorporation process starts with the prospective client completing a client questionnaire First step is to specify the name of the company the Bermuda attorneys will check to see if the name is available and register it Client questionnaire will ask the client to set out the ownership structure of the captive right through to the ultimate beneficial owner In the case of individuals who own at least 5% of the company, a personal declaration form must be completed The Bermuda Monetary Authority checks shareholding structure to ensure that the proposed shareholders are fit and proper as required by Bermuda exchange control legislation Changes of shareholder controllers of the captive must also be approved

60 Incorporation The application to incorporate the company will also set out the proposed authorized share capital of the company Minimum share capital for an insurance company will be US $120,000 but may be higher Bermuda insurance companies must meet minimum solvency and capital requirements depending, amongst other matters, on the class of the insurance company The attorneys for the client will apply to incorporate the company to the Registrar of Companies and the Bermuda Monetary Authority Controller of Foreign Exchange Each application is dealt with individually there is no off the shelf incorporation procedure in Bermuda

61 Timing of incorporation The application to incorporate the captive can be made before the application to licence the company as an insurance company It can also be made simultaneously with the insurance application some clients want to have the company incorporated and organized prior to licensing application being made Incorporation process is generally fairly quick typically, should allow 3-4 days but can sometimes be expedited Once approved for registration, company will obtain a certificate of incorporation and exchange control approval to issue shares Company can now be organized

62 Organization of the exempted company The process of organizing the exempted company will involve three separate meetings The first meeting will be the provisional directors meeting, who will be the subscribers to the company s memorandum of association The provisional directors will allot shares to the shareholders, call the statutory meeting of the shareholders and adopt the company s byelaws The second meeting is the statutory general meeting of shareholders whose most important role is to appoint the first board of directors of the company. This will be the first annual general meeting of the company The third meeting is the first board meeting of the newly appointed directors

63 Directors Bermuda exempted companies must have at least two directors The directors need not be Bermuda resident and need not own shares in the company The Bermuda company must however have a minimum of two representatives who are ordinarily resident in Bermuda. Can be satisfied by: - two directors who are ordinarily resident in Bermuda - a secretary who is ordinarily resident in Bermuda and a director who is ordinarily resident in Bermuda - a secretary who is ordinarily resident in Bermuda and a resident representative

64 Structural Considerations Tax advice should be taken as to the implications of mind and management being exercised onshore US Must take care not to infringe state insurance laws It is possible for the Bermuda company s bye-laws to specify that board and shareholder action should not be taken onshore US A company must hold an annual general meeting at least once in each calendar year but need not be held in Bermuda Directors of Bermuda companies must act in good faith in what they reasonably consider to be the best interests of the company

65 Insurance Application Application to register as an insurance company must be made to the Bermuda Monetary Authority ( BMA ) Insurance division The application must be made before 5PM on a Monday and is heard on the Friday of the same week by the Assessment and Licensing Committee ( ALC ) of the BMA The ALC may call on the assistance of the Technical Advisory Group ( TAG ) composed of industry representatives The ALC will generally request the attendance of TAG in all but the pure captive (Class 1) applications ALC/TAG may approve the application, defer it pending clarification of certain matters or reject it if the business case can not be substantiated

66 Insurance application The application is made on a prescribed government form (Form 1B) The application will have a cover letter from the attorneys summarizing the application and a business plan substantiating the business case for the captive Will set out the type of risk to be assumed, the loss history, limits of risk to be retained and information relating to reinsurance by Bermuda captive and rating of reinsurer Pro forma financials should be included ideally over a 5 year period and should be actuarially evaluated to test adequacy of reserves, solvency margins and liquidity ratios

67 Insurance application Details of service providers in Bermuda must be set out in the application Insurer will need to disclose who will act as its insurance manager, auditor, loss reserve specialist and principal representative Principal representative has certain statutory obligations under the Insurance Act for example, it must disclose if the insurer is breaching any of its solvency, liquidity ratio and minimum capital requirements The BMA Compliance Department will also as part of its review of the proposed owners of the captive ensure that the shareholders are fit and proper

68 Risk-based regulation Bermuda has always had a risk-based approach as the core of its regulation of insurance companies Bermuda implements this philosophy by a class-based system of regulating insurance companies The Insurance Act divides Bermuda insurers into 4 main classes and has recently reorganized class 3 insurers into 3 different classes Class 1 insurers are essentially single parent pure captives and are subject to the least onerous regulation Class 4 insurers comprise the highly-capitalized property catastrophe reinsurers and are subject to the highest level of regulation

69 The class-based system of regulation Class 1 single-parent captives writing risk of the parent only Class 2 multi-owner captives writing up to but not exceeding 20% unrelated business Class 3 insurers whose unrelated business represents more than 20% but less than 50% Class 3A insurers whose unrelated business exceeds 50% of net premium written and where unrelated business premium does not exceed $50 million Class 3B insurers whose unrelated business exceeds 50% of net premium written and where unrelated business premium exceeds $50 million Class 4 insurers and reinsurers writing direct excess liability and/or property catastrophe reinsurance risk Bermuda has also recently introduced concept of special purpose insurers

70 Minimum capital and surplus requirements All insurers must meet certain minimum capital and surplus requirements depending on class All insurers must have a minimum fully paid-up share capital of US $120,000 (in the case of Class 4 companies, there must be at least $1,000,000 paid-up capital) All insurers must maintain minimum capital and solvency margins and a minimum liquidity ratio All insurers must prepare statutory financial statements and file these with the BMA together with a statutory financial return (Class 1 insurers need only file the statutory financial return)

71 Minimum Solvency Margin requirements Class of Insurer / 3A / 3B 4 Greater of: a) Minimum Statutory Capital & Surplus $120,000 $250,000 $1 million $100 million b) Premium Test: First $6 million of Net Premium Written 20% 20% 20% 50% * Net Premiums Written in excess of $6 million 10% 10% 15% 50%* c) Loss Reserve Test: Loss and Loss Expense Reserve 10% 10% 15% 50% * For Class 4 insurers, test is 50% of NPW with maximum deduction for reinsurance of 25% of GWP

72 Bermuda Captive Options Form stand alone captive or participate in segregated account arrangement For larger companies makes most sense to establish their own captive insurer Advantage of establishing own captive is that company exercises greater control of the captive In the case of smaller companies, a more cost-effective option may be to participate in a segregated account structure at least until programme premium volume reaches more sustainable level Bermuda pioneered the concept of separate account companies with Private Act legislation but has introduced public cell legislation which is ideal vehicle for segregated account/rent-a-captive structures

73 Bermuda s public cell legislation The Segregated Accounts Companies Act 2000 (as amended) ( SAC Act ) Bermuda had statutory cell technology through Private Acts of Parliament facilitating separate account companies prior to introduction of public cell legislation Bermuda terminology is that of segregated account companies or SACs (terminology different but concept essentially same as protected cell companies (Jersey/Guernsey) or separate portfolio companies (Cayman) SAC Act contains detailed provisions which statutorily ring-fence assets of one segregated account or cell from liabilities of another cell or from the general account (or core account ) SAC Act permits payment of cell-specific dividends and provides for cellspecific liquidations

74 Segregated Accounts Company PCC owner A Segregated Account Company (SAC) is a single legal entity with on Board of Directors. The company is divided into a number of Cells and a Core. Cell G Cell H Control Cell A The assets of an individual cell in Bermuda are legally protected from the claims of creditors, other than the creditors of that particular cell. Cell F Cell E Core Cell C Cell B Non-voting shares Cell D Cell owner

75 The SAC Act Registration Process Registration system offers a swift and cost-effective process annual cost of registration is $250 plus there is an annual fee of $265 per segregated account up to a maximum of $1,050 Creates a public registration system maintained by the Bermuda Registrar of Companies Insurance companies can apply for automatic registration by filing notice in the prescribed form under the SAC Act

76 Title Slide Second Header

77 WHY BERMUDA? Philip Barnes Aon

78 BERMUDA S VALUE PROPOSITION Largest captive domicile Blue chip offshore financial centre Professional infrastructure Quality of workplace The 3 rd largest insurance center worldwide Key geographical location One stop shop access to insurance and reinsurance markets Competitive prices Regulatory flexibility Segregated Accounts & SPV Legislation No Income or Capital taxes

79 Source: Aon s Global 1500: A Captive Insight, 2007 GLOBAL DOMICILE ANALYSIS

80 BERMUDA THE LEADING DOMICILE By origin of captive parent UNITED STATES - Bermuda Vermont British Virgin Is Hawaii 123 -S. Carolina89 - Barbados 81 - Ireland 52 CANADA - Barbados 84 - British Columbia 12 -Cayman 7 - Bermuda 19 UNITED KINGDOM - Guernsey Bermuda 64 - Ireland 30 EUROPE - Luxembourg Bermuda 78 - Guernsey 47 ASIA / OCEANIA - Singapore 56 - Bermuda 36 - Guernsey 18 - Australia 14 LATIN AMERICA - Bermuda 21 - Cayman 6 - British Virgin Is. 4 Source: A.M. Best captive directory

81 BERMUDA MONETARY AUTHORITY Bermuda Incorporations of Insurance Companies for Class Class Class Class Long Term Composites (3&LT, 4&LT) Total

82 one stop shop

83 WHY BERMUDA?

84 Questions???