29 June 2005

The Web

Catching a tiger by its tail

News that captives are coming to Malta has been a favourite subject among insurance practitioners. Certainly this is good news for the financial services industry and augurs well for a number of professional practitioners who have been active to promote the island as a competitive and well regulated centre.
The attractiveness of the legislation can be measured by the ease that a body corporate licensed in another jurisdiction to carry out any insurance business or to provide insurance management or broking services, may be authorised to continue as a company formed or registered in Malta. A tangible fiscal benefit is that of an outright exemption from duty under the Duty on Documents and Transfers Act, 1993 in respect of any contract of insurance relating to a risk situated outside Malta. Furthermore, captive management services are also zero rated for VAT purposes under the Value Added Tax Act. A company carrying on affiliated insurance is taxable at the normal company rate of tax which currently is 35%. However, if such a company underwrites risks situated outside Malta, it is able to operate the foreign income account and non-resident shareholders may benefit from the refund of tax on distributions from this account bringing the effective tax rate to 4.17%. It is not surprising that the market leaders in captive management are slowly but steadily focusing on the opportunities in the sector available in the island. But what has made captives the flavour of the month. One may say that traditionally captives were in the domain of established centres such as Bermuda, Cayman Islands, Isle of Man, Hong Kong, British Virgin Islands, some US States, Dublin and Luxembourg. The reason for their success is simple to explain. We notice over the past decades that corporate insurance buyers have determined the value of captives and have found ways to utilise them in developing strategic risk financing programs. Once captive owners saw the numerous advantages that are associated with captives, they rarely returned to the conventional insurance market. They are proven to be the right and cost effective solution for organised insurance services. If anything, they found additional, creative ways to utilise their captives. There is a very competitive market among countries to attract captive insurance companies. But captive owners were not the only ones to see the opportunities from this alternative risk transfer method. Movement to captives also provided opportunities for many types of service providers. Captives allowed their parent companies to release unique services that were previously provided by a single insurance carrier. Critical insurance services such as administration/management, actuarial, legal, accounting, claims and loss control all had to be included in the captives operations. Having waxed lyrical about the attributes of captives, one may step back and ask what is a captive insurance company?
A captive insurance company is, in its purest form, a subsidiary company formed to insure or reinsure the risks of its parent and / or associated group companies. Captives are usually formed to provide alternative risk management solutions to that of the conventional insurance market. The administration of a captive is usually, though not always, outsourced to a specialised captive manager. There are a number of reasons why captives may provide a better means of risk management than the conventional market. The main points are factors such as costs, flexibility and improved claims management. With increased frequency, corporate insurance buyers and mid-sized business owners are seeing the advantages of captive ownership. They see the opportunities that captives can provide and have been expanding their usage in a number of different ways. But they are not the only people that see the opportunity in captive ownership. To start with, premiums charged by commercial insurers include amounts to cover the insurer's profit margin and overheads.
With captives one tends to save on such overheads. As these can be significant in case of larger corporate structures it goes to show why captives are considered to be more cost effective. Captives can also be flexible in their operation. To quote an example we can say that when the market is soft, the captive can take advantage of the low rates by reinsuring a relatively large proportion of its risks. The low cost of reinsurance allows the captive to build its reserve base. Conversely the market hardens, the captive is able to retain a larger proportion of its risks, and can maintain cover for its parent even when commercial insurance is unavailable or prohibitively expensive. Why some may criticise captives as being impersonal when handling claims one cannot underrate their efficiency.
This is manifested where the insurer is a captive, the claims handling procedures can be dictated by management, cutting down on the delays and bureaucracy that are often a necessary part of the claims handling procedures of commercial insurers. This is because of the clever way that captives generally retain a portion of the overall risk and reinsure the balance. The financial regulator MFSA is committed to the development of the captive insurance sector, and last year it announced that legislation was being introduced to allow the setting up of Protected Cell Captives (PCC's) within the jurisdiction Companies Act (Cell Companies Carrying on Business of Insurance) Regulations, 2004; Legal Notice 218 2004 .Some may well ask what is a protected cell company and how can it be used to exploit the unique features in Malta?
The answer is that the unique qualities of a protected cell company, or PCC, can be thought of as being a standard limited company that has been separated into legally distinct portions or cells. The revenue streams, assets and liabilities of each cell are kept separate from all other cells. Each cell has its own separate portion of the PCC's overall share capital, allowing shareholders to maintain sole ownership of an entire cell while owning only a small proportion of the PCC as a whole. In terms of the PCC regulations a ‘Cell Company’ is a company constituted or converted into a cell company having within itself one or more ‘cells’ for the purposes of segregating and protecting the cellular assets of the company in accordance with the Regulations. A cell company is a single legal person. A ‘Cell’ is in turn a class of shares within a cell company designated as a cell and created for the purpose of segregating and protecting cellular assets belonging to the company in the manner provided by the Regulations. A cell is not bestowed with separate legal personality. Due to its inbuilt flexibility a PCC can provide a means of entry into captive insurance market to entities for which it was previously uneconomic.
The overheads of a protected cell captive can be shared between the owners of each of the cells, making the captive cheaper to run from the point of view of the insured. An interesting aspect of the island’s insurance legislation caters for the registration and operation of captive insurance companies which are termed “Affiliated Insurance Companies” (“AICs”). To clarify this term one notes that “Affiliated Insurance” encapsulates the business of an insurance company which is registered in Malta and whose business of insurance is restricted to risks originating with shareholders or connected undertakings or entities. The flexibility of the vehicle can be demonstrated by the ease that AIC s may insure risks originating from a wide range of persons including: parent companies; associated or group companies; individuals or other entities having a majority ownership or controlling interest in the AIC, and members of trade, industry or profession associations insuring risks related to the particular trade, industry or profession. Typically AIC ’s have to carry an equalization reserve but the companies are exempted from this obligation if the net premiums written in a financial year in respect of that financial year are less than Lm500,000 (approx. EUR250,000); or the net premiums written in a financial year in respect of that business are less than 4% of net premiums written in the financial year in respect of all its general business are less than Lm l million Maltese liri (approx. EUR2,500,000), and company has no equalisation reserve to bring forward from previous financial year.
Malta’s coming of age in the insurance market is being crowned by the attention it is enjoying in the captives sector. For captive insurance companies, the Island has the necessary local expertise to ensure that the formation and running of a captive insurance company can be achieved with maximum ease. Malta is becoming an increasingly attractive domicile for multinational companies in which to form a captive. One year since joining the EU we have taken bold steps towards implementing a robust regulatory regime which is in line with the European Union Insurance Directives.
The ability to ‘passport’ insurance to all territories within the European Economic Area (EEA) and the double tax agreement held with 42 countries are clear examples of Malta’s growing appeal. With the tide in our favour we can strive to become the Bermuda in the Mediterranean.

The author is a partner in PKFMALTA, an audit and business advisory firm

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