Earlier this year, the National Bureau of Economic Research
announced that the most recent economic recession actually ended in June 2009. While the economic statistics may support this conclusion, in the days of stimulus packages, low investment returns and expiring tax cuts, cash is still king. With the spotlight remaining on cash and liquidity, many have turned their attention to their captive, eyeing its balance sheet and wondering if the captive’s liquidity could be put to better use in the hands of the captive’s owner. The captive owner may see the liquidity as an opportunity to support capital projects, business expansion or perhaps to simply support continuing operations.
Luckily for Cayman captive owners, there are a number of
opportunities to access investments in their captive without sacrificing the longevity of the captive programme. Loan backs, return premiums, return of additional paid-in capital and policyholder or shareholder dividends are all considered viable options, each with their own merits. Experience indicates that cash dividends paid to captive shareholders ranks high on the list of options. Having witnessed a notable rise in cash dividends declared, and expecting this trend to continue through this fiscal year, this article will focus on discussing the shareholder dividend option in greater detail.
Ensuring that captive owners and the captive’s board of directors
are aware of the process and fully understand the many operating, accounting, regulatory, legal and tax considerations before the dividend declaration can, excusing the pun, pay dividends in the future.
Accounting and financial
considerations To trivialise the first step of any cash dividend declaration would
simply be to ensure there is the fiscal ability to pay the dividend. While this may be easily articulated, it should nevertheless be scrutinised. While one may first look to the asset section of the balance sheet, focus should move down the page to the shareholder’s equity and, more specifically, the retained earnings. Without sufficient retained earnings, further discussion would be pointless. Assuming your captive has reaped the benefits of past underwriting profits and investment yields, we can assume your captive is ready to calculate an appropriate dividend.
When examining the retained earnings, the board should clearly
understand the calculations and assumptions made to derive this figure. Are the retained earnings based on audited year-end financial statements or perhaps a mid-year set of management financial statements? Are insurance reserves adequate and based on a recent actuarial report? Is the actuarial report based on the most recent loss history and loss trends? It is extremely important that the board understands the possible effect any recent unfavourable loss trends may have on future actuarial loss estimates. Sufficient surplus today may be insufficient by the end of the fiscal reporting period.
While retained earnings may be the key balance in a captive’s
ability to pay a dividend, the board must further consider the impact that the dividend would have upon the overall capital of the captive and ensure its continued successful operation. The board must continue to understand the current level of risk retained in the captive, coupled with the additional level of risk to be retained in future years. Not all premium-to-equity ratios work for all captives. It would be advisable for the board to seek the input of its risk managers, actuarial advisors and captive managers in forecasting
40 CAYMAN CAPTIVE
its future operations and in identifying the ideal level of total equity. The board does not want to be found in a situation where a taxable dividend is declared only to realise a non-deductible contribution is required shortly thereafter to support the programme.
Undoubtedly, at some point in the infancy of the process, the
question of whether there is simply enough cash to pay the dividend will arise. In order to provide a definitive response, one cannot just examine the most recent bank statement. The captive must clearly identify the free cash position, or rather the cash available that is otherwise not encumbered. Is the cash being held for the benefit of loan-to-value ratios in order to satisfy a letter of credit? Is the cash being held to satisfy other stakeholders such as the Internal Revenue Service to meet the United States asset test under the Internal Revenue Code Section 953(d) for elected captives? Also worthy of mention is the access limitation to funds should the funds be held in a 114 trust.
Perhaps equally important is future cash flow requirements. Are
losses maturing or in need of payment? Will the reduction in cash have a material impact on the asset mix such that it could put the captive out of compliance with its own investment policies? Accordingly, the board must pay close attention to current and long- term cash flow needs.
Liquidation of investments to pay dividends is commonplace, as
one might imagine. If there are constraints on cash then liquidating investments is the next logical step. Once again, the board must also be aware of the effects liquidating all or part of an investment portfolio could have on the captive. Should the identified assets be above water, then the sale would crystallise and thus accelerate any unrealised gains that may trigger a taxable capital gain to either the captive or its owners. On the other hand, should a captive have capital losses carried forward that are set to expire, then it may be advantageous and prudent tax planning to sell the investments to
“ The board does not want to be found in a situation where a taxable dividend is declared only to realise a non-deductible contribution is required shortly thereafter to support the programme.”
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76