Captive insurance is a form of self-insurance involving a relationship between the insured and the insurer whereby the insured owns the insurer. Captive insurance arrangements are often used because a business has unique risk management needs, or because the company wants the tax advantages that may come along with using captive insurance. Captive insurance can cover most types of risk. However, the captive insurance company must be set up and administered properly to provide the full scope of benefits to the insured. This setup process includes choosing an appropriate domicile. A captive’s domicile is its primary jurisdiction. Domicile matters because it dictates which laws and regulations apply to the captive.
The Basics: What Is a Captive Insurance Domicile and Why Does It Matter?
A captive insurance domicile is the jurisdiction in which the company is formed and regulated. According to the Center for Insurance Policy and Research, over 70 jurisdictions have captive legislation. Bermuda is the largest single captive jurisdiction, followed by the Cayman Islands. In the United States, Vermont is a popular domicile; it is considered a leader in captive legislation.
Choosing a domicile is one of the first items that must be considered when forming a captive. A captive’s domicile determines many of the parameters that the company must follow. For instance, domicile will affect the following aspects of the captive insurance structure:
- Capitalization rates
- Fees and taxes
- Regulatory environment
- Local captive community
- Onshore/offshore implications
- Support services
Even seemingly external considerations like the domicile’s political stability can have an impact on the captive insurance company. Ultimately, a captive’s domicile can have a huge effect on the captive’s success and its usefulness to its affiliate or parent company. Favorable regulatory and tax treatment can significantly impact operations and the ability to successfully insure affiliate entities.
Factors To Consider When Choosing a Captive Insurance Domicile
Each domicile has its own set of rules, laws, and benefits for captive insurance companies. As a result, a thorough examination of the local landscape before choosing a domicile is often worth the time and effort involved.
The regulatory environment refers to the requirements and oversight that the local government has over the captive insurance company. The following are common restrictions that might need to be considered:
- Solvency requirements
- Underwriting limitations
- Requirements to obtain policy and rate approval before offering policies
- Limitations on the types of coverage offered
- Restrictions on “unrelated business”
- Investment restrictions
- Reporting and auditing requirements
- Loss reserve requirements
A domicile that has too little regulation can be chaotic. Such conditions can end up producing poor transparency and credibility, leading to problems across the industry. On the other hand, a domicile in which insurance is overly regulated can have a stifling effect on operations. Ideally, the domicile you choose will strike the right balance between necessary regulation and the flexibility needed to accomplish a business’s goals.
Tax laws can vary a great deal from one domicile to the next, especially with respect to offshore captive insurance companies. Creating a captive insurance company can have significant tax advantages, so companies often want to ensure they choose a domicile that allows them to take full advantage of those money-saving benefits. Taxes that may need to be considered include:
- Income tax
- Premium tax
- Potential tax incentives, benefits, or credits
- Tax related to investments
- Federal excise tax
- Self-procurement tax
Many domiciles impose a general annual fee on captives. Formation costs are often imposed as well. These might include registration fees, stamp taxes (for offshore domiciles), and general incorporation expenses. While these fees may be nominal compared to potential tax obligations, the overall taxation apparatus should still be a consideration in the overall domicile analysis.
The decision to form a captive insurance company should be based on a thorough analysis of the risks and benefits relevant to your unique business needs. While tax considerations may be a component of this analysis, it is essential to understand that the primary motivation for establishing a captive should be the effective management and mitigation of risks associated with your business operations.
The overall stability of the domicile’s legal and political environment can have a profound impact on the captive. In some cases, the local political situation may have minor impacts, especially in the short-term, but the political landscape of a domicile can have far-reaching effects and influence the stability of a captive company and the relative feasibility of operations for captive companies en masse.
Stable political climates reduce the risk of sudden policy change requirements or significant regulation changes. Simply put, stable domiciles promote a more predictable business environment. Safety and security may be concerns for workers and owners as well.
Companies might also want to consider the proximity of the domicile compared to the parent or affiliate companies. Communication between the two entities is important, and if communication is strained or difficult, that can lead to problems with oversight and the ability to conduct business.
With today’s increasingly global economy, physical proximity may be less important, but the ability to perform oversight checks and communicate with stakeholders is still critical. If the captive is not going to be nearby, there should be a plan in place to address communication and oversight.
Favorable and unfavorable domiciles will gain a reputation for their treatment of captives. Regulations that look good on paper may not always be the best option in practice. Consider how many other captives are in that domicile. A strong local captive community indicates favorable relations with the government and the public, which often includes a supportive environment to foster successful operations.
Positive relationships among industry professionals, including service providers, make maintaining and operating the company much easier. Choose a domicile that clearly encourages captives to set up shop there and wants them to flourish in their community for years to come.
Getting the Domicile Right for Your Captive Insurance Company
Choosing the right domicile for a new captive insurance company has many nuances. Experts writing for the American Bar Association note that it can be “likened to the solving of a Rubik’s cube” because decisions affect many other pieces of the captive insurance company and the parent company. The selection process can feel complicated and overwhelming, but it is a critical decision that will directly affect the captive’s success. Taking the time and effort to get this decision right is an investment in your company’s future success. Wisterm may be able to help with this critical process. To learn more about the benefits of creating a captive insurance company and choosing the right domicile to meet your goals, call (718) 865-8777 today.