Jurisdictions

The march of the onshore captives

Offshore jurisdictions such as Bermuda and Cayman may be synonymous with the captives industry, but there’s a growing number of US states competing to bring captives to their shores while also working hard to attract new captive insurance formations.

As US states increase their efforts, the decision of whether to domicile offshore or onshore becomes more difficult to make. But, according to Michael Maglaras, founder and principal of Michael Maglaras & Company, the answer is obvious.

He believes that onshore US jurisdictions are competing “more favourably than we could have anticipated" with offshore jurisdictions and, over the past 15 years, he’s seen a “paradigm shift”.

“In a tax-exempt world, tax-exempt organisations such as US healthcare systems are large users of captives. For many years, offshore domiciles advantaged those tax-exempt organisations,” he says.

“But in the past 15 years legislation in US domiciles has changed. There is now candidly no reason for a tax-exempt parent with a captive to be outside the US. There is zero reason for that to happen.”

Maglaras adds that a second factor has come into play in this decision-making process: the amount of offshore compliance is becoming a “terrible burden” for captives owners—tax-exempt or otherwise. Offshore captives owners must ensure they are compliant with international regulations concerning taxes and anti-money laundering.

“Between the extra regulatory burden offshore and the changes in legislation domestically in the US, I’m not seeing a reason to be outside the US at all any more. I know that’s a profoundly provocative statement, but I believe it,” Maglaras concludes.

Delaware’s Department of Insurance (DoI) agrees, adding that for captives owned by US-based owners, there is little reason to domicile offshore.

“More than 35 US states, districts, territories, and Native American tribes are now captive insurance domiciles. Many of these domiciles have cultivated and grown a domestic industry consisting of captive associations and service providers,” says the DoI.

“This trend will continue as will its level of sophistication. The result is that US captive owners no longer need to look offshore as they did 20 years ago because there are now multiple domicile choices in the US from which to choose.”

“There is now candidly no reason for a tax-exempt parent with a captive to be outside the US.”
Michael Maglaras, Michael Maglaras & Company

A different story

During the 1960s US regulations made it “prohibitively expensive to form or operate captives onshore,” explains Fenhua Liu, director of the captive insurance division at the State of Connecticut Insurance Department.

Today it’s a different story. “Many states have quality infrastructure, political stability, very experienced captive service providers and regulators,” she says. Additionally, the offshore tax benefits that once lured captive owners offshore may now be reduced or no longer exist.

“Evolving federal tax reforms or proposals are discouraging US corporations from moving intangible assets and related profits abroad to controlled subsidiaries, including captives with lower tax rates offshore,” says Liu.

She adds that several leading offshore captive domiciles have recently joined a new two-pillar plan to “reform international taxation rules and ensure that multinational captive owners pay a fair share of tax wherever they operate” and that, if a US captive chooses an offshore domicile, “they may incur procurement tax liability and some offshore fees”.

Finally, says Liu, many offshore US captives have onshore service providers which can add “unnecessary travel time and meeting expenses”.

Driven by an extra regulatory burden and a reticence to travel amid a pandemic, the popularity of offshore jurisdictions may be experiencing a wane and US jurisdictions are primed to jump in.

Liu lists a number of ways US jurisdictions are competing with offshore jurisdictions, noting that more onshore US domiciles are now providing more flexibility, adopting a risk-based regulatory approach, reducing onerous regulations and procedures, and enabling the saving of international business-related taxes and avoiding possible procurement tax liability.

Delaware’s DoI adds: “A prospective captive insurance company owner now has multiple choices in the US, all of which will offer stability. The competition between the US jurisdictions for captive insurance business is fierce.

“This means that when a captive owner is dissatisfied with a particular US domicile, they can find regulators in another US domicile willing to work with them.”

Regulators and regulation are playing a key role here.

“If you’re a captive consultant/broker/owner, you want to be regulated and you want good regulation. Why? Because you want someone at a regulatory level looking over the shoulders of service providers to give you the extra comfort that things are being managed in an efficient and professional way,” says Maglaras.

“You welcome the scrutiny. The more scrutiny you have that is business-friendly, the better your captive functions.”

Good captive regulators, says Maglaras, are always business-friendly and understand business. “They’re business-friendly at the same time as they exert good regulatory scrutiny,” he says, adding that the two aspects are not incompatible.

“Captives can better meet a high-tech company’s insurance needs.”
Fenhua Liu, State of Connecticut Insurance Department

Regulation is key

Delaware and Connecticut are prime examples of relatively “young” (in the captive insurance world) US states working hard to build their reputation as approachable and efficient regulators.

Despite the pandemic, in 2020 Connecticut recorded 35 percent growth in captives by approving six new captive insurance companies. The growth, Liu says, has been fuelled by the captive division’s outreach initiative, which is aimed at expanding Connecticut’s presence and reputation as a domestic captive domicile.

“With the support of the Connecticut Captive Insurance Association and the Connecticut Society of CPAs in developing an outreach plan, the department and the National Network of Accountants conducted education outreach to accountants on the benefits of captive insurance for their clients,” says Liu.

The blueprint to make Connecticut an even more captives-friendly jurisdiction include plans to submit captive insurance legislative changes for the 2022 Legislative Session, the introduction of innovative products to bolster captives’ resilience to the physical and financial impacts of climate change, and reducing the minimum capital and surplus for certain captives according to a risk-based and principle-based regulatory approach.

Improving the department’s captive insurance regulatory services by ensuring it is “approachable, making quick decisions, and efficient” and increased collaboration with stakeholders on outreach efforts to educate industry stakeholders are also high on the agenda.

Delaware’s DoI believes it may have reported the largest US state year-over-year change, with 70 new captives in 2020.

The state has come a long way—in 2009, Delaware had only 38 captive insurers, now, it has over 730 active captives.

The DoI says that, as US captive insurance domiciles each have substantially similar captive insurance laws, it looks for areas where it can offer “flexibility to increase our ability to compete, such as with our newly passed change to dormancy rules”.

In mid-July, the governor of Delaware, John Carney, signed into law Senate Substitute 1 for Senate Bill 36 (SB1SB36) which allows a captive to enter dormancy after 12 consecutive months of inactivity.

Previously, captives were required to be inactive for a calendar year before they could enter dormancy—a captive that stopped writing business mid-year would therefore have to wait 18 months to file for dormancy, paying premium taxes and submitting statements throughout that time.

The bill also offers clarity to provisions regarding insuring a parent company and allows captives to be classified as a registered series.

“In truth, what sets Delaware apart is its consistent, stable, and experienced regulation,” says the DoI. “Captive owners and managers prefer dealing with regulators they know, and because of our knowledgeable and experienced team, we have been able to build trust.

“Managers know that when they pick up the phone or send our team an email, we will reply quickly and accurately.”

The captive insurance division also includes members fluent in multiple languages, including French, German, Lithuanian, Russian, and Spanish, which, says the DoI, has allowed it to “build a worldwide presence despite the small size of our state and our team”.

To maintain its high level of regulation and expertise, the DoI invests in its team so that “they can respond to the market with effective regulation”.

The DoI adds: “We see results when we invest in training and encourage attention to innovation—and, in turn, we stand out. For example, Delaware is the only International Center for Captive Insurance Education-trained organisation of any captive insurance domicile with $5 billion or more of annual premium.”

“Because of our knowledgeable and experienced team, we have been able to build trust.”
Delaware’s Department of Insurance

A renaissance

Looking to the future more generally, there is a sense of optimism about the captives industry and onshore jurisdictions in particular.

Liu expects a trend of relocation onshore as the “offshore tax benefits may not exist” and “onshore domiciles are more competitive in flexibility, regulatory fees and the onshore regulator experience and expertise”.

Liu expects more mid-size companies to turn to captives, driven by the hardening market and the impact of the pandemic. High-tech companies are also likely to take advantage of captives.

“Captives and high-tech companies are innovative and fast-changing. Captives can better meet a high-tech company’s insurance needs,” she says.

In terms of coverage, Delaware’s DoI expects coverages related to risks such as cannabis, cryptocurrencies, and pandemics to “generate greater interest among captive insurers”.

Maglaras is sanguine about the future of captives and onshore jurisdictions. Indeed, as a captive insurance consultant in business for 34 years, 2020 was the steepest growth his company has experienced, all amid a pandemic.

“For many decades, captives have done things such as replace coverage. What we’re seeing in this shape-shifting market is less about that and more about augmenting coverage,” he says.

Many of Maglaras’ clients have gone through a very difficult commercially purchased cyber renewal.

“There is not a single one of our clients with a commercially purchased cyber policy that has been able to replicate the amount limit they had at renewal last year,” he says, adding that, increasingly, in difficult casualty lines a captive will be used not to replace the whole tower of liability cover but to augment it.

Maglaras concludes: “We are going to go through a renaissance of captives in the next 20 years.”

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Image Credit: Shutterstock.com / Sunward Art

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