CAPTIVE REGULATION
Of particular note are expanding efforts towards captive regulatory coordination under the auspices of the likes of the International Association of Insurance Supervisors (IAIS), and the essential role played by the Captive Insurance Companies Association (CICA) in giving voice to its members as the only North American non- domiciliary oriented captive association.
In addition to domiciliary developments, an array of permissible structural choices for forming a captive has blossomed: regular corporations, not-for-profit corporations, mutuals, reciprocals, limited liability companies (single and multi-member), protected cells, incorporated cells, and more. Coupled with several US federal tax election choices such as Section 953(d) onshore taxation, Section 831(b) investment income-only taxation and check-the- box look-through or disregarded entity tax treatment for non- insurance companies, the terrain has become vastly more complex and sophisticated. The goal, as always, is to identify and implement the right structure for the intended programme, something that has become a far more challenging task today thanks to the range of captive options available.
All this captive growth and complexity didn’t occur without periodic threats to the industry, however. An existential challenge arose in 2007–08, when the US Internal Revenue Service proposed disallowance of all tax benefits associated with onshore (and electing offshore) captives filing consolidated, group tax returns. Almost in unison, the captive associations and their members rose to the occasion with technical, policy and political counter-arguments. Very quickly and almost without explanation, the menacing regulations were withdrawn by the Treasury, in a large part thanks to the lobbying efforts of associations such as CICA.
More recently, the Non-Admitted and Reinsurance Reform Act provisions buried in the Dodd-Frank Financial Reform legislation appear to have upset—unintentionally at the federal level and intentionally at the state level—the inter-state level playing field regarding state direct placement taxes on premiums paid to captives. Also looming on the horizon—with indeterminate application to captives—is the EU’s onerous Solvency II capital standards initiative for European insurers and reinsurers, which will also be applied, if not in full, to other domiciles seeking equivalence.
Meanwhile, as group captives continue to flourish, the old rent- a-captive format is gradually giving way to statutory cellular structures using the force of law to buttress ring-fencing among the single legal entity’s segregated parts (variously, depending on the domicile, called accounts, portfolios or cells). A further ongoing refinement is rapidly gaining favour: the incorporated cell with
its own legal personality and board of directors, as evidenced by enabling legislation enacted in the District of Columbia, Vermont and Montana, with the Cayman Islands and Bermuda now in the process of following suit.
So how have the regulatory scales shifted over the past two decades? In general, the old notion held in the 1980s and 1990s that offshore jurisdictions offer both lax regulation and better tax results than their onshore counterparts has become outmoded. International organisations such as the International Monetary Fund (IMF), Organization for Economic Cooperation and Development (OECD), and Financial Stability Board (FSB) have imposed tougher regulatory, transparency and accountability standards on offshore locations to thwart money laundering, tax evasion and terrorism funding, and the 1986 Tax Reform Act helped level the playing field for offshore and onshore federal income taxation. As a result, the onshore-offshore decision has become more nuanced over recent years.
Changes on the horizon What can we expect in the future for captive insurance regulation? We could start with the eventual replacement of the generally accepted accounting principles (GAAP) with the international financial reporting standards (IFRS), which will create a very different measuring stick for valuing line items on the audited financial statements of a captive. Not surprisingly, the friction points between risk retention groups (RRGs) and the non-domiciliary state insurance regulators will continue, despite the recent release of a sympathetic, if less than forceful, government accountability office report on the matter.
Captives undoubtedly face future regulatory, tax and legal challenges, many of which will be difficult to predict, but most will probably involve more compliance paperwork and an associated increase in operating costs. Nonetheless, CICA remains confident that captives will prevail and, indeed, prosper. A key reason for this is that self- and group-funding entities are not premised on any regulatory or tax break. Rather, captives succeed because of the simple economic principle that the parties involved in any given business, profession or activity know and understand the associated risks involved in their work and how best to mitigate them. Perhaps CICA’s motto would better reflect this reality if it were “aligning pocketbooks with better behaviour”, a truism that not even occasional regulatory impediments can impair. l
Thomas Jones is a partner at McDermott, Will & Emory. He can be contacted at:
tjones@mwe.com
CICA | Forty years of captive leadership 41
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