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Family offices, captives, trusts and Bermuda

Ashley Fife of Appleby

Frederic Reiss assisted the Ohio-based mining company Youngstown Sheet & Tube Company, to establish subsidiaries, later known as captives, which exclusively insured the company’s mining operations. The captive insurance concept was thus born as a sophisticated extension of self-insurance.

The regulatory burden and costs of operating either United States or Lloyd’s-based captives in the 1960s inspired Mr Reiss to seek an alternative jurisdiction to establish captives. Ultimately, the location, reputation and political stability of Bermuda proved appealing. Bermuda is now the world’s leading offshore captive domicile with approximately 900 captives together holding assets exceeding $85 billion.

Numerous Fortune 500 companies in industries spanning manufacturing, mining, healthcare and property have established Bermuda captives to insure workers’ compensation, general liability, errors and omissions and directors’ and officers’ liability insurance. Bermuda captives are increasingly insuring reputational, regulatory, credit, terrorism, mergers and acquisitions, environmental, satellite technology, political and cybersecurity risks and funding employee benefits.

Many profitable family-owned businesses and the family offices supporting them should consider the benefits of captives. Contractors, retailers, physicians and other healthcare providers, hotels, restaurants, transportation and car dealers are increasingly establishing small captives to cover risks including business interruption, reputational, regulatory risks and the risk of loss of a key supplier, customer or employee.

Family-owned and more widely-held businesses based in Latin America — particularly in Mexico, Columbia, Peru and Chile — have experience utilising Bermuda captives to insure against property and, increasingly, political risk. This has been facilitated by Bermuda’s network of tax information exchange agreements with those countries.

The commercial reasons for establishing captives include:

• Obtaining insurance when insurance of the particular risks is unavailable, or only available at high cost, in the commercial insurance market.

• The ability to insure risks that would be considered deductibles or excluded risks under policies available in the commercial market.

• Avoiding swings in premiums, uplifts, overheads, brokerage fees and other costs and disadvantages of insuring with commercial insurers.

• Streamlining, and maintaining control over the claims process.

• Pooling and investing premiums for future distribution to captive owners if not required for claims.

• Direct access to the lower cost reinsurance market.

• Insulating the captive’s capital and gains from the captive owner’s creditors.

• Creation of customised insurance programmes.

• Creation of a profit centre.

• Expanding knowledge of business risks and being better placed to mitigate them.

• Availability in many jurisdictions of special tax treatment including tax deductions for premiums and, particularly for offshore captives, tax deferral on undistributed gains held in the captive.

A family business may arrange for the trustee of a family trust to own the captive. If structured effectively, this may:

• Further insulate the captive’s assets from creditors of the insured parent company or family members.

• Facilitate estate planning and minimisation of estate, generation skipping and a range of other taxes that are potentially imposed on family members in the United States or elsewhere.

• Mitigate the impact of forced heirship and community property regimes in civil law countries.

• Facilitate the family’s philanthropic objectives.

Captives must insure bona-fide insurable risks. In order to enjoy the tax benefits that captives can facilitate, insureds are typically required to demonstrate that there is a risk-transfer and that excessive premiums are not being paid.

Formation, administration, and opportunity costs as well as capitalisation requirements are among the factors considered in feasibility studies to determine whether to establish or insure with a captive. While numerous factors are relevant, captives may be most viable where the captive can charge annual premiums of at least $750,000 or considerably less when rent-a-captives are utilised.

Bermuda law provides appropriate regulation levels for different classes of insurers based on the relationship between the insurer, its shareholders, policyholders and the type and scope of the captive’s business.

Bermuda captives are not subject to the Solvency II requirements with which Bermuda recently gained equivalence.

Access to captive insurance is facilitated by Bermuda rent-a-captives. With rent-a-captives, a sponsor, who is typically unrelated to the insured, contributes the statutory capital to the captive and charges fees to the insured for use of the sponsor’s capital and for licensing and operating the captive.

As an alternative to pooling insureds’ risk, capital and surplus, Bermuda law permits rent-a-captives to keep segregated accounts. With segregated account companies, the assets and liabilities in each insured’s account are legally separated from accounts of other insureds and are protected against claims from other insureds’ creditors.

Bermuda provides a streamlined review process that facilitates captive formation — often in three to six weeks subject to the quality of information provided — and assistance from skilled captive managers.

Captives in Bermuda are well supported by our strong reinsurance sector, and the island’s practical regulatory regime for special purpose insurers has facilitated Bermuda to become the preferred domicile for insurance-linked investments.

Bermuda collateral trusts may be used by Bermuda captives to provide security for the captive’s obligations where a business has insured with a fronting insurer with the intent of the fronting insurer reinsuring with a captive. Collateral trusts are considered more cost-effective than letters-of-credit, which have traditionally been used to provide security.

While the nature of each captive should be considered, many Bermuda captives do not have FATCA reporting requirements. Those that do benefit from Bermuda’s Model 2 intergovernmental agreement with the United States that enables reporting entities to report directly to the Internal Revenue Service and not to the Bermuda Government, thereby avoiding potential inconsistency in information reported.

Bermuda’s strength in captives, reinsurance, funds and trusts should not be overlooked by family businesses and family offices.

Lawyer Ashley Fife is a Senior Associate with the Private Client and Trusts Practice Group at Appleby. A copy of Mr. Fife’s column can be obtained on the Appleby website at www.applebyglobal.com.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.