Re-domestication: To Move or Not to Move (Strategic Risk Solutions 180 Newsletter)
Re-domestication: To Move or Not to Move
The growth in captive domiciles has led to competition among domiciles for not only new captives but existing captives. Should captive owners be considering re-domestication? In this newsletter we review reasons to consider re-domestication and how to re-domicile. This article draws on information presented by P. Bruce Wright of Dewey & Lebeouf and Brady Young of SRS in our October webinar.
The reasons to re-domesticate are similar to those driving the original domicile decision (Regulatory, Tax, Infrastructure, Logistics and Perception). As captives mature and the domicile landscape changes, it may be necessary or advantageous to re-domicile an existing captive or form a new captive. Like the domicile choice, the re-domestication decision will be unique to each captive and based on its particular circumstances.
Regulation - there are two situations which might be a reason to re-domesticate on regulatory grounds: a change in the domicile's regulatory position relative to other domiciles and a change in the captive's business plan.
• Change in regulatory position: periodically domiciles may become concerned about lasses of business written in captives and restrict activities in those areas, for example warranty business. Captives underwriting these classes may consider re-domesticating to more favorable domiciles. The emergence of new domiciles and the expansion of captive regulations also alter the relative regulatory landscape. For example, several domiciles have passed legislation allowing LLC captives and not for profit captives. A captive looking for a "pass through" structure now has a greater choice of domiciles and structures. This may change the location of its most favorable domicile. Other examples include rent a captives and agency captives which have historically only been acceptable in offshore domiciles. Several US domiciles have recently included legislation including rent a captive (or sponsored captives) and agency captives.
• Change in Business Plan: certain coverages can only be written onshore. The Department of Labor requires that captives writing ERISA benefits be subject to onshore domestic regulation. Similarly only licensed domestic insurers, including captives, can access TRIA. Changes in business plans to include these coverages will require an offshore captive to re-domesticate onshore or form a branch.. Conversely a domestic captive which increases the amount of third party business it is writing may need to re-domesticate offshore. US domestic captive regulations typically restrict the amount of unrelated third party business underwritten. Offshore domiciles provide more flexibility in writing third party business.
Tax - changes in the tax regulations can cause a captive to consider re-domesticating. The recently announced proposed regulation, discussed later in this newsletter, is an example of this and if passed may cause some captives to look at re-domestication offshore. Other situations which may merit re-domestication from tax purposes include:
• Trapped losses: the dual consolidated loss rule means that losses in an offshore captive can not be taken in a consolidated return. If an offshore captive anticipates that there will be continued losses, moving onshore would allow its results to be consolidated into the group, offsetting income elsewhere.
• Direct placement taxes: these taxes are imposed in approximately 40 states on transactions with non-admitted insurers. They are typically equivalent to the surplus lines rate. Some captive domiciles, such as New York, do not apply the tax on risks located in that state. At 3-4% of premium this can be a significant saving if a captive owner has a large portion of its risk located in the captive's domicile state.
Other Reasons - Infrastructure, logistics and perception can all be reasons to re-domesticate
· Changing Infrastructures: increasing costs may prompt a captive to look at other domiciles purely for economic reasons Turnover of staff among service providers can impact service levels. Temporary work permits and temporary assignments in offshore domiciles increase turnover and have led some captives to consider re-domesticating onshore.
· Meeting Logistics: given the activity level of most captives and the requirement and tax reasons to have one or more meetings in the domicile each year, the ease of reaching and communicating with the domicile is a factor in domicile selection. With the increase in the number of domiciles and the narrowing of the differences there may be sound logistically reasons to re-domesticate to a domicile closer to the parent's home.
· Perception: increased scrutiny by the captive owner's management may make it inappropriate for a captive to continue to be located in certain domiciles. With more onshore alternatives, internal questions about the location of offshore insurance subsidiaries in some domiciles that are considered tax havens have increased
How to Re-domesticate - for those captives that conclude that it is beneficial to re-domesticate, how do you do it? There are three main options available.
1. Merger - this is the easiest way to re-domesticate. The captive moves its capital and its business and continues operations in the new domicile. If the domicile has a re-domestication statute then the transfer is quite seamless. Corporate and insurance filings are required and there are tax issues to consider. The captive may want the transaction to be treated as a reorganization for tax purposes, so the expenses of the merger are deductible.
2. Assumption Reinsurance: in situations where a merger is not feasible, the next best option is assumption reinsurance. This requires all insureds of the captive to agree to look to the assuming reinsurer for coverage and release the captive of its obligations. With no residual business, the captive can then be liquidated. This structure is treated as reorganization for tax purposes. The drawback is being able to access all insureds of the captive, including any additional insureds under the policy. For example, a Directors & Officers liability policy would require a release from all individual directors and officers of the company. Obtaining releases is further complicated if any of the insureds or fronting insurers are insolvent.
3. Run off of old captive: this is the least efficient option as capital is trapped in the old captive. With new capital required for the new captive, there will be a short term increase in capital requirements. There will also be increased costs of operating both captives. One option to accelerate the run-off is to commute the captive's coverage, although this may trigger a taxable event if the captive claimed a tax deduction on the original premiums.
Partial Re-domestication - the regulatory benefits of being onshore can be achieved without fully re-domesticating. Several single parent captives have established onshore branches to establish an US regulatory presence. This structure has been mostly used to write ERISA benefits under the Department of Labor requirements but some US domiciles allow other risks to be underwritten by branch captives. Offshore group captives have created greater flexibility by forming an onshore Risk Retention Groups. This can be done by forming a domestic subsidiary or affiliate where there isn't an exact match between owners and insureds of the captive.
Conclusion - the question of domicile should be periodically reviewed as circumstances change. Captive owners should ask themselves "if we were starting over where would we domicile". If the answer is not the current domicile, then is there enough justification to move. Moving a captive is not a simple exercise. There are regulatory, tax and operational issues to be addressed. It costs money to move and it takes time to move. Re-domestication, while a valid option to consider, should be viewed as a five year or longer decision.
A recording of the original webinar may be viewed at https://strategicrisks.webex.com under Event Recordings in the Event Center.
The growth in captive domiciles has led to competition among domiciles for not only new captives but existing captives. Should captive owners be considering re-domestication? In this newsletter we review reasons to consider re-domestication and how to re-domicile. This article draws on information presented by P. Bruce Wright of Dewey & Lebeouf and Brady Young of SRS in our October webinar.
The reasons to re-domesticate are similar to those driving the original domicile decision (Regulatory, Tax, Infrastructure, Logistics and Perception). As captives mature and the domicile landscape changes, it may be necessary or advantageous to re-domicile an existing captive or form a new captive. Like the domicile choice, the re-domestication decision will be unique to each captive and based on its particular circumstances.
Regulation - there are two situations which might be a reason to re-domesticate on regulatory grounds: a change in the domicile's regulatory position relative to other domiciles and a change in the captive's business plan.
• Change in regulatory position: periodically domiciles may become concerned about lasses of business written in captives and restrict activities in those areas, for example warranty business. Captives underwriting these classes may consider re-domesticating to more favorable domiciles. The emergence of new domiciles and the expansion of captive regulations also alter the relative regulatory landscape. For example, several domiciles have passed legislation allowing LLC captives and not for profit captives. A captive looking for a "pass through" structure now has a greater choice of domiciles and structures. This may change the location of its most favorable domicile. Other examples include rent a captives and agency captives which have historically only been acceptable in offshore domiciles. Several US domiciles have recently included legislation including rent a captive (or sponsored captives) and agency captives.
• Change in Business Plan: certain coverages can only be written onshore. The Department of Labor requires that captives writing ERISA benefits be subject to onshore domestic regulation. Similarly only licensed domestic insurers, including captives, can access TRIA. Changes in business plans to include these coverages will require an offshore captive to re-domesticate onshore or form a branch.. Conversely a domestic captive which increases the amount of third party business it is writing may need to re-domesticate offshore. US domestic captive regulations typically restrict the amount of unrelated third party business underwritten. Offshore domiciles provide more flexibility in writing third party business.
Tax - changes in the tax regulations can cause a captive to consider re-domesticating. The recently announced proposed regulation, discussed later in this newsletter, is an example of this and if passed may cause some captives to look at re-domestication offshore. Other situations which may merit re-domestication from tax purposes include:
• Trapped losses: the dual consolidated loss rule means that losses in an offshore captive can not be taken in a consolidated return. If an offshore captive anticipates that there will be continued losses, moving onshore would allow its results to be consolidated into the group, offsetting income elsewhere.
• Direct placement taxes: these taxes are imposed in approximately 40 states on transactions with non-admitted insurers. They are typically equivalent to the surplus lines rate. Some captive domiciles, such as New York, do not apply the tax on risks located in that state. At 3-4% of premium this can be a significant saving if a captive owner has a large portion of its risk located in the captive's domicile state.
Other Reasons - Infrastructure, logistics and perception can all be reasons to re-domesticate
· Changing Infrastructures: increasing costs may prompt a captive to look at other domiciles purely for economic reasons Turnover of staff among service providers can impact service levels. Temporary work permits and temporary assignments in offshore domiciles increase turnover and have led some captives to consider re-domesticating onshore.
· Meeting Logistics: given the activity level of most captives and the requirement and tax reasons to have one or more meetings in the domicile each year, the ease of reaching and communicating with the domicile is a factor in domicile selection. With the increase in the number of domiciles and the narrowing of the differences there may be sound logistically reasons to re-domesticate to a domicile closer to the parent's home.
· Perception: increased scrutiny by the captive owner's management may make it inappropriate for a captive to continue to be located in certain domiciles. With more onshore alternatives, internal questions about the location of offshore insurance subsidiaries in some domiciles that are considered tax havens have increased
How to Re-domesticate - for those captives that conclude that it is beneficial to re-domesticate, how do you do it? There are three main options available.
1. Merger - this is the easiest way to re-domesticate. The captive moves its capital and its business and continues operations in the new domicile. If the domicile has a re-domestication statute then the transfer is quite seamless. Corporate and insurance filings are required and there are tax issues to consider. The captive may want the transaction to be treated as a reorganization for tax purposes, so the expenses of the merger are deductible.
2. Assumption Reinsurance: in situations where a merger is not feasible, the next best option is assumption reinsurance. This requires all insureds of the captive to agree to look to the assuming reinsurer for coverage and release the captive of its obligations. With no residual business, the captive can then be liquidated. This structure is treated as reorganization for tax purposes. The drawback is being able to access all insureds of the captive, including any additional insureds under the policy. For example, a Directors & Officers liability policy would require a release from all individual directors and officers of the company. Obtaining releases is further complicated if any of the insureds or fronting insurers are insolvent.
3. Run off of old captive: this is the least efficient option as capital is trapped in the old captive. With new capital required for the new captive, there will be a short term increase in capital requirements. There will also be increased costs of operating both captives. One option to accelerate the run-off is to commute the captive's coverage, although this may trigger a taxable event if the captive claimed a tax deduction on the original premiums.
Partial Re-domestication - the regulatory benefits of being onshore can be achieved without fully re-domesticating. Several single parent captives have established onshore branches to establish an US regulatory presence. This structure has been mostly used to write ERISA benefits under the Department of Labor requirements but some US domiciles allow other risks to be underwritten by branch captives. Offshore group captives have created greater flexibility by forming an onshore Risk Retention Groups. This can be done by forming a domestic subsidiary or affiliate where there isn't an exact match between owners and insureds of the captive.
Conclusion - the question of domicile should be periodically reviewed as circumstances change. Captive owners should ask themselves "if we were starting over where would we domicile". If the answer is not the current domicile, then is there enough justification to move. Moving a captive is not a simple exercise. There are regulatory, tax and operational issues to be addressed. It costs money to move and it takes time to move. Re-domestication, while a valid option to consider, should be viewed as a five year or longer decision.
A recording of the original webinar may be viewed at https://strategicrisks.webex.com under Event Recordings in the Event Center.
