Sep 2024
Bermuda is the world’s leading domicile for captive insurance companies, with over 600 active captive licences on its register generating over US$24 billion in gross written premium1. Having formed the first modern captive in 1962, Bermuda still maintains its global lead. The jurisdiction has earned international credibility as a leading global insurance and reinsurance market over the past 50 years and is among the world’s top three insurance and reinsurance markets, along with London and New York, experiencing recent growth due to the current hard market and a growing trend for increased diversification to write emerging risks such as climate, cyber and employee benefits given the current lack of suitable solutions in the commercial market.
Why Bermuda?
Bermuda provides ideal economic, political and infrastructure conditions to support the development of its captive industry and has remained resilient in the face of unprecedented events, including the Covid-19 pandemic and the changes driven by the shifting regulatory landscape in the name of global transparency.
Bermuda offers a “one-stop shop” with three generations of service providers ranging from captive managers to attorneys and accountants with unparalleled experience supporting the insurance industry on the island. With so many commercial insurance writers in Bermuda, a captive owner can come to the island to hold meetings with both their captive manager and their reinsurer in the same geographical location.
The widely-respected Bermuda Monetary Authority (BMA) acts as a gatekeeper to Bermuda’s insurance and reinsurance markets. Every application to incorporate and license a captive insurance company undergoes a thorough review.
The BMA’s ‘proportionality’ approach ensures firm but sensible regulation to international standards in regulating captive insurers. This risk-based regulatory approach recognises, among other things, the more limited risks that captive insurers pose. The BMA does not apply a Solvency II-type regime to captives and therefore the supervisory regime for captives is less onerous than that applicable to commercial insurers. Bermuda was officially granted Solvency II third-country equivalency as of 24 March 2016 by the European Union.
The BMA has successfully balanced the right regulation for the captive industry and separately, its Solvency II equivalent prudential regime.
Corporate Structure
The Insurance Act 1978 of Bermuda (as amended) distinguishes between “captive insurers”, being insurers that predominantly insure the risks of their parent and/or affiliates, and “commercial insurers”, being insurers that predominantly insure third-party risks. Insurance business is broadly grouped into either general or long-term business.
There are three classifications of general captive insurers:
- A Class 1 insurer, often called a “pure captive” is wholly owned by one person and intends to insure only the risks of that person, or it is an affiliate of a group and intends to insure only the risks of any other affiliates of that group or of its own shareholders.
- A Class 2 insurer is wholly owned by two or more unrelated persons, and not less than 80% of its net premiums must relate to insuring the risks of any of its owners or their affiliates or insuring risks that arise out of the business or operations of those owners or their affiliates.
- A Class 3 insurer is a captive insurer not otherwise registrable as Class 1 or 2. For regulatory purposes, Class 3 insurers are generally regarded as “limited purpose insurers” and are subject to less rigorous supervision than general commercial insurers but more than Class 1 and 2 captive insurers.
There are two classifications of long-term captive insurers:
- A Class A insurer is wholly owned by one person and intends to carry on long-term business consisting only of insuring the risks of that person or its affiliates.
- A Class B insurer is wholly owned by two or more unrelated persons and intends to carry on long-term business where not less than 80% of the premiums and other considerations will be written to insure the risks of any of those owners or their affiliates or to insure risks that arise out of the business or operations of those owners or their affiliates.
- A company is also registrable as a Class B insurer if it would be registrable as Class A except that not all of its business, but at least 80% of the premiums and other considerations written, insure the risks of its owner or the owner’s affiliates or arise out of the business or operations of its owner or its affiliates.
Over the decades, a number of different types of captive structures have been used. Formerly the preserve of the Fortune 500 and FTSE 100 companies, captives now provide benefits to organisations of all sizes and industries and are used to underwrite a variety of insurance lines, ideally those with relatively predicable claim rates.
Recent Developments
Part of Bermuda’s attractiveness to captive owners is Bermuda’s adherence to international regulatory standards and its resulting stellar reputation. Bermuda has embraced the global fight against financial crime and has signed up for the Foreign Account Tax Compliance Act (FATCA), adopted the Common Reporting Standard and supported The Organisation for Economic Co-Operation and Development’s (OECD) Forum in Base Erosion and Profit Shifting (BEPS) measures. Over time this has been followed by the introduction of corporate tax, entry into mandatory disclosure regimes, economic substance laws and exchanges of information between governments.
Such changes, with roots in global transparency and regulatory standards, further delineate the importance for captive owners to seek out domiciles, such as Bermuda, that adhere to global standards whilst remaining highly competitive.
Economic Substance
Bermuda enacted the Economic Substance Act (the ES Act) and its related regulations in 2018 in respect to the requirements of the OECD’s Forum on Harmful Tax Practices and the European Union’s (EU) Code of Conduct Group. The OECD Forum on Harmful Tax Practices determined in April 2022 that Bermuda was effectively monitoring resident entities’ compliance with the economic substance regime and on that basis, the EU Code of Conduct Group (Business Taxation) has placed Bermuda on its ‘white list’.
The criteria under the ES Act serve to place limits on entities operating in Bermuda without substance. Substance requires ‘adequate’ levels of expenditure, people and premises along with evidence of certain ‘core income generating activities’ of certain relevant activities (including, among others, the relevant activity of ‘insurance’). There are no prescriptive rules as to what is deemed ‘adequate’ and an entity will be assessed against the requirements based on the nature, scale and complexity of the business of that entity.
For Bermuda captives who are carrying on the relevant activity of ‘insurance’ (other than in the cases where such entity is non-Bermuda tax resident, for example, having made an election under section 953(d) of the U.S. Internal Revenue Code to be treated as a domestic company), complying with the ES Act requires captives to consider the amount of economic substance they have in Bermuda. It requires that captives (i) are managed and directed from Bermuda, (ii) have core-income generating activities undertaken in Bermuda, (iii) maintain adequate physical presence in Bermuda, (iv) incur adequate operating expenditure in Bermuda, and (v) have adequate full-time employees with suitable qualifications in Bermuda.
Bermuda captives have been able to demonstrate that they satisfy the criteria under the ES Act as they will hold an adequate number of board and/or committee meetings in Bermuda (based on the nature, scale and complexity of the captive’s business) at which meetings key executive board members may travel to Bermuda for the purpose of attending such meeting(s). In addition, captives frequently appoint Bermuda resident directors and employ a third-party service provider (such as an insurance manager) who will undertake the core income generating activities of the captive in Bermuda (such core income generating activities for the relevant activity of insurance include predicting and calculating risk, insuring or reinsuring against risk, providing client services and preparing regulatory reports).
As such, captives need to carefully consider the amount of economic substance they have in Bermuda which includes evaluating whether or not it is the intent of the captive to place employees on the ground (which would typically not be required for a straightforward captive) and if not, the level of sufficient and high-quality resources in Bermuda which will support compliance with the criteria under the ES Act.
The requirements under the ES Act are enforced by the Bermuda Registrar of Companies. Non-compliance of the criteria under the ES Act can result in the Registrar issuing requests for information, requiring on-site audits and imposing civil penalties in respect of previous relevant financial periods.
Insurance Code of Conduct
The BMA issued a revised Insurance Code of Conduct on 1 September 2022 (the Code). The revised Code expanded the duties, requirements, standards and principles to be observed by all insurers and, in particular, those relating corporate governance and fitness for purpose.
The key changes to the corporate governance provisions of the revised Code were to either introduce or further elaborate on the need for board composition and specifically the use of independent non-executive directors, board effectiveness review processes and an insurer’s conduct of business. It is worth noting that the proportionality principle applies to all updates within the revised Code and therefore an insurer will be assessed on its compliance with the Code in a proportionate manner relative to the nature, scale and complexity of its business.
The impact of this change is that insurers may now need to prepare and implement policies and procedures assessing its board composition, including its fitness and propriety, as well as processes and procedures for setting the factors against which a board will assess itself and the cadence of that review process.
Finally, section 8.1 of the revised Code provides that an insurer shall conduct its business with integrity and have clearly documented and established policies and procedures to manage or avoid situations in which a conflict of interest may arise between the insurer’s business and that of its clients.
International Tax
The OECD in 2015 issued guidance on BEPS to ensure that companies are not exploiting gaps in rules to artificially shift profits to low or no tax jurisdictions. At the end of 2022, the EU unanimously agreed to implement Pillar 2, the 15 per cent global minimum tax component of the OECD’s dual-pillar campaign.
In response to the foregoing, the Government of Bermuda issued a series of consultation papers regarding the proposed introduction of a corporate income tax (CIT) that would be applicable to each Bermuda tax resident entity and Bermuda permanent establishment that are part of a Multinational Enterprise Group (MNE) with consolidated revenue of at least €750 million or more. It is worth noting that the CIT is not an OECD version of the Pillar 2 rules but Bermuda’s own minimum corporate income tax. On 27 December 2023, the Bermuda Corporate Income Tax Act 2023 became law and will be effective for fiscal years beginning on or after 1 January 2025.
The introduction of CIT in Bermuda and the changes driven by Pillar 2 will influence strategic decision making regarding captive formations, the uses of captives and the jurisdictions they are located in. However, it may be that the impact of a minimum tax may be less relevant to captives– firstly, it is not uncommon for captives to already be registered as domestic taxpayers in the U.S. and thereby subject to U.S federal income tax (or paying tax elsewhere) and secondly, it is false to assume that tax benefits are always the primary consideration. Indeed, many captive owners do not view tax benefits as a value driver given significant other advantages to incorporating a Bermuda captive.
At this stage, the potential impact of CIT remains to be seen and more guidance is to be issued on its implementation and rollout. Captive insurers should ensure that they are prepared for such requirements, involving their tax teams and senior management as soon as possible.
The Future
The Bermuda Government has actively nurtured its captive market for more than 50 years and remains responsive to changes in the insurance market, to new ideas and techniques in both insurance and broader commercial circles and has demonstrated commitment to fully adhere to global disclosure and transparency standards imposed by bodies such as the OECD and the implementation and regulation of such standards.
In today’s increasingly globalised world, captive domiciles that adhere to global standards effectively is of upmost importance. Given the increased compliance burden and to ensure that the benefits to be gained by the use of a captive are not compromised, this must be balanced by effective and proportionate regulation, a commitment to innovation and flexibility, and a talented and specialist workforce – all of which are Bermuda’s success areas. This is why Bermuda continues to be trusted by captive managers and investors worldwide.
1 BMA Captive Report 2022: https://cdn.bma.bm/documents/2023-12-11-14-01-29-BMA-Captive-Report-20228-Dec.pdf