Developments Influencing Captive Insurance Domiciles: Insights from SRS

In a recent webinar hosted by Strategic Risk Solutions (SRS), experts Britni Strong, CPA, and director of client services at SRS's Cayman Islands office, and Michael Archangel, part of SRS Advisors and a former regulator with the North Carolina Insurance Department, discussed key factors influencing captive domicile selection, including tax implications, regulatory requirements, market conditions, and operational considerations.

The following is an overview of the key themes discussed in the webinar, encompassing considerations for both onshore (US-based) and offshore captives.

Self-Procurement Tax: Self-procurement tax is a significant factor influencing domicile selection. Captives are increasingly domiciling in their home states to avoid these taxes. For example, a Texas-based parent forming a captive in Vermont would face a 4.85 percent self-procurement tax in addition to Vermont's 0.4 percent premium tax. In contrast, domiciling the captive in Texas would only incur a 0.5 percent premium tax, avoiding the self-procurement tax altogether.

Aggressive State Actions: States like Washington have been notably aggressive in enforcing self-procurement taxes, targeting large companies and imposing significant taxes on captives insuring risks within the state. Washington requires captives to register, pay a 2 percent tax on premiums for risks in the state, and maintain substantial capital and surplus.

Market Conditions: Onshore domiciles are aggressively pursuing business, promoting a business-friendly environment, and attending industry conferences. This competition has resulted in more options and greater flexibility for captives.

Impact of COVID-19: The shift to virtual environments during the pandemic has reduced the need for travel, making local domiciles more appealing. Businesses prefer setting up captives in their home states to avoid the complexities of travel and remote management.

Flexibility in Underwriting: US domiciles, traditionally focused on first-party risk, are becoming more comfortable with third-party risks. This includes agency captives and producer-owned reinsurance captives. They have also started lowering their capital requirements to attract more captives. For instance, protected cell captive insurance companies, which traditionally may have required a $250,000 capital deposit, are now seeing reduced requirements.

Regulatory Considerations: Offshore jurisdictions must comply with the Common Reporting, requiring entities to file specific tax forms. Anti-money laundering and terrorism financing compliance are particularly stringent in Cayman, driven by the need to combat negative perceptions. Offshore domiciles also have strict data protection and cyber-security laws, often more rigorous than those in the United States. Additionally, business continuity plans are essential due to the risk of natural disasters in many offshore locations.

Global Minimum Tax and Economic Substance Laws: The Organization for Economic Co-operation and Development (OECD) global minimum tax (Pillar Two), is being considered by some jurisdictions like Bermuda and Barbados. Cayman does not require entities to file for tax purposes locally if they are compliant with their home jurisdiction's tax requirements. Economic substance laws mandate that captives must engage in actual business activities within their domiciles, not just serve as a post office box for tax benefits.

Capital Requirements: Offshore domiciles generally have lower unencumbered capital requirements, typically ranging between $100,000 and $200,000, while onshore requirements are around $250,000. Offshore domiciles may also allow the base regulatory capital to be pledged to commercial insurance partners, a flexibility not usually permitted in US jurisdictions.

Tax Considerations for Offshore Captives: Offshore captives must consider various tax implications, including the completion of Form 5471 for controlled foreign corporations and the complexities of the 953(d) election, which allows the captive to be treated as a US taxpayer. The 953(d) election is difficult to reverse, so thorough consultation with tax advisers is essential.

Due Diligence and Perception: Due diligence requirements in offshore jurisdictions, particularly in Cayman, can be more comprehensive and demanding than in onshore jurisdictions. Despite concerns about the OECD's gray list and blocklisting, none of the top offshore domiciles currently face significant issues. Cayman was previously on the gray list but has since complied with all requirements to be removed quickly.

Data Protection: Data protection and cyber-security laws in offshore jurisdictions tend to be stricter than in the United States, particularly regarding cross-border data transfers. This can be both a benefit and a potential headache, depending on your preferences.

Business Continuity Plans: Many offshore locations are prone to heavy rains and hurricanes, making business continuity plans crucial. Most domiciles are fully electronic with backup plans and staff in multiple locations to ensure continuity during local disruptions.

Meeting Travel Requirements: Travel requirements for meetings vary. Some onshore domiciles mandate annual or biennial meetings, whereas offshore domiciles might require meetings less frequently. This can be a logistical and perception issue, particularly if board members are negotiating with unions or other parties sensitive to the location of these meetings.

Fixed Regulatory Fees: Offshore domiciles usually have fixed regulatory fees, which can be more predictable than the percentage-based fees typical of onshore domiciles, making budgeting easier.

Speed of Setup: Setting up a captive can be faster offshore. Entities can often be up and running in 6 to 8 weeks, compared to longer setup times in other jurisdictions.

SRS suggests that both onshore and offshore domiciles offer unique advantages and challenges, and businesses must carefully evaluate their specific needs and circumstances. Consulting with experienced tax advisers and insurance managers is essential to navigate this complex landscape effectively.