CAPTIVE 101
From a, Legal, Regulatory, Actuarial and Taxation Perspective
Speakers
Speakers:
• Neil, Horner, Partner and Head of Corporate, Attride-Stirling &
Woloniecki
• Scott Slater, Tax Manager, PWC
• Darren Ma, Actuary, PWC
• Leslie Robinson, Assistant Director, Insurance Licensing &
Authorization, Bermuda Monetary Authority
Moderator:
• Beverley Todd, Executive Vice President, JLT Insurance
Management
Bermuda Captive 101 –
A legal primer
Why form a captive in Bermuda
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Prudent and flexible regulation
Speed to market
Access to the Bermuda reinsurance market
World class infrastructure
Pre-eminent captive domicile
Excellent judicial system
Intellectual capital
Bermuda Captive 101 –
A legal primer
The Path to Licensing
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Select service provider team
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Apply to incorporate the company
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Apply to licence the company
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Incorporate, organise and capitalise
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Registration as an insurer/reinsurer
Bermuda Captive 101 –
A legal primer
Choosing the team
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Insurance manager to manage the captive and principal representative
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Auditors
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Lawyers and corporate administrators
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Actuary if required
Bermuda Captive 101 –
A legal primer
Captive formation
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Captive formation involves incorporation of a company under the Companies
Act 1981 and registration under the Insurance Act 1978
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Quite distinct processes – possible to run both simultaneously or apply to
incorporate ahead of licensing application
Bermuda Captive 101 –
A legal primer
Incorporation
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Application to incorporate company made on specific application form to
Registrar of Companies and Bermuda Monetary Authority (“BMA”) Controller
of Foreign Exchange
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Details of proposed ownership structure in captive must be disclosed right
through to ultimate beneficial owners
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BMA vets shareholders to make sure they are “fit and proper” persons - must
also be approved as ‘shareholder controllers’ of insurance company
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Individuals owning more than 5% of voting equity of captive must also
complete a personal declaration form
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Though we do not have “off the shelf” incorporations, incorporation process is
very streamlined and can have ‘same day’ approval
Bermuda Captive 101 –
A legal primer
Insurance application
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Application to register as an insurer must be made to the BMA Insurance Division
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Application made on a Monday of each week and considered at the weekly Friday
meeting of the Assessment and Licensing Committee (“ALC”) of the BMA
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ALC may call upon assistance of Technical Advisory Group (“TAG”) composed of
industry representatives in all classes except “pure captive” (Class 1 applications)
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ALC/TAG may approve the application with or without conditions, approve it
conditional upon production of certain information, defer it or decline it if business
case cannot be substantiated
Bermuda Captive 101 –
A legal primer
Mechanics of insurance application
• Application will have cover letter from the captive’s attorneys together with the business plan
for the captive setting out the business case for the captive
• Pre-incorporation form must be completed
• Proforma financials should be included preferably over 5 year period and ideally actuarially
evaluated to test adequacy of reserves, solvency margins and liquidity ratios
• Details of service providers should also be included (insurance manager, auditor, loss reserve
specialist and principal representative
Bermuda Captive 101 –
A legal primer
Business Plan
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Details of Shareholder
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Proposed insurance program
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Capitalisation of the company
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Directors
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Service Providers
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Reinsurance arrangements
Bermuda Captive 101 –
A legal primer
Steps to insurance registration
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Incorporation
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Organisation of company
– Hold board and shareholder meetings to:
• issue shares
• adopt bye-laws
• appoint auditors and insurance manager
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Capitalise captive
– Amount of capital will depend on class of insurer
Bermuda Captive 101 –
A legal primer
Application for insurance registration
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File formal application with the BMA
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Formal application is on form 1B- will be identical to pre-incorporation form
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Formal registration can be the date consent is received or as the shareholder
wishes
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Company can then write business
Bermuda Captive 101 –
A Tax Perspective
Agenda
– Introduction
– US Tax Benefits to forming a Captive
– US Taxation of a Captive
– Summary
Bermuda Captive 101 –
A Tax Perspective
Insurance - Understanding the U.S. Tax Benefits:
Captive versus Self Funding
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FAS 5 Standard for accruing liabilities
• “Estimable and Probable” Standard
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US Tax Standard for deducting accrued liabilities under IRC §461 “Economic
Performance Standard”
• Liability must be “fixed and determinable”
• Economic performance occurs within 8 ½ months (i.e., payment) restrict
deductibility to ‘cash method’
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US Insurance Company Taxation (Subchapter L):
• May establish (i.e., deduct) a reserve which is ‘fair and reasonable’
• May earn certain revenues over period of obligation (e.g., Extended
Service Contracts)
Bermuda Captive 101 –
A Tax Perspective
Insurance - Understanding the U.S. Tax Benefits:
Captive versus Self Funding
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In a consolidated group, the federal income tax benefit of a captive is not
deductibility of premium, it is the ability to establish deductible loss
reserves
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Achieve Tax/GAAP parity
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Special Treatment for “Small Insurance Companies”
• IRC §501(c) Tax Exempt –
– Gross Receipts < $600,000 on a controlled group basis
– >50% GR must be insurance premiums
• IRC §831(b) Election
– Taxed only on investment income – Premium levels $350,001
to $1.2M
Estate and Wealth Transfer Benefits
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Bermuda Captive 101 –
A Tax Perspective
Definition of Insurance: What is insurance for U.S. tax purposes?
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Neither the Internal Revenue Code nor the Treasury Regulations define the term
“insurance” or “insurance contract.”
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In 1941, the Supreme Court in LeGierse determined insurance did not exist
where two linked insurance contracts failed to shift risk of loss away from
insured. Established requisite components of insurance:
• Presence of “insurance risk”
• Required “risk shifting” and “risk distribution”
• Insurance was found in its commonly accepted sense
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A number of Rulings and cases have defined these components over time.
Bermuda Captive 101 –
A Tax Perspective
Entity Level Taxation: IRC §953(d) Election
(‘D’ Company) - Election to be treated as a US domestic insurance company – taxed on
worldwide income
• Requirements of the ‘d’ election
• Must be ‘insurance’ company (would be subject to tax under Subchapter L)
• 25% or more shares owned by U.S. persons
• Revenue Procedure 2003-47 (guidance/steps for making the election)
• US Office and Assets
– Assets of affiliate (if filing consolidated return)
– Unencumbered US assets
– Letter of Credit
• Election specifics
• Due by filing of first US tax return (typically 3/15 unless extended to 9/15)
• Election irrevocable without consent
• Cannot re-elect for five years
Bermuda Captive 101 –
A Tax Perspective
Entity Level Taxation: IRC §953(d) Election Advantages
• Exemption from the US federal excise tax on premiums paid to a foreign insurance
company
• Exemption from the withholding tax imposed on certain types of fixed and periodic
(“FDAP”) income from US sources
• Exemption from the “branch profits tax” imposed on certain earnings of foreign
corporations that are engaged in a US trade or business
• Ability to hold meetings and conduct business activities within the US
– Does not alleviate state regulatory concerns
• Ability to join in filing a consolidated US federal income tax return (if applicable)
• Ability to more freely invest in US property
• Ability of US shareholders to enjoy the benefit of the dividends-received deduction
Bermuda Captive 101 –
A Tax Perspective
Entity Level Taxation: IRC §953(d) Election Disadvantages
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Potential for double taxation on distributions made to shareholders
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Mandatory change of the company’s tax year end to December 31 or the
year end of the parent company in consolidation
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Subject to current taxation on worldwide income with no treaty benefits
available
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Subject to Dual Consolidated Loss Rules
Bermuda Captive 101 –
A Tax Perspective
Entity Level Taxation: IRC §953(d) Election
– 953(d) Company – US tax filings
• Form 1120-PC – annual
• Form TD F 90-22.1 – annual – if own foreign bank accounts
• Estimated Tax Payments - quarterly
– Audit/Accounting issues
– Requires tax accrual at the entity level
Bermuda Captive 101 –
A Tax Perspective
Entity Level Taxation: IRC §953(c)(3)(C)
(‘C’ Company) - Foreign insurance company may elect to treat RPII as effectively
connected income
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Requirements
• Must be ‘insurance’ company (would be subject to tax under
Subchapter L)
• Must be a CFC (25% or more shares owned by U.S. persons)
• Election irrevocable without consent
• Revenue Procedure 2003-47
– Guidance/steps for making the election
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VERY RARE
Bermuda Captive 101 –
A Tax Perspective
Shareholder Level Taxation: CFC
U.S. has no authority to tax foreign corporations not engaged in a U.S. trade or business
• Controlled Foreign Corporation or “CFC” Rules (1962)
• Two tier test
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‘US Shareholder’ defined
» 10% or more voting stock
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Collectively owning >50% vote or value
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For “Insurance Income” – special >25% Rule
• Deemed distribution provisions
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Insurance income
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Foreign personal holding company income
» Interest, dividends, capital gains, etc.
• Audit/Accounting issues
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Generally no tax accrual at the CFC level
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FIN 48 – Determination if a US trade or business
Bermuda Captive 101 –
A Tax Perspective
Shareholder Level Taxation: RPII CFC
Related Person Insurance Income, or “RPII” Rules (1986)
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Defined as insuring the US persons who control or is controlled by the
‘insurer’
– Required RPII / Non-RPII split of management accounts
• ‘Any’ Shareholder replaces 10% voting shareholder for these purposes
• 25% or more replaces the >25% ownership test
• De minimus exception
– Less than 20% RPII
– Less than 20% vote value held by related persons
• Audit/Accounting issues
– Generally no tax accrual at the RPII CFC level
– FIN 48 – Determination if a US trade or business
Bermuda Captive 101 –
A Tax Perspective
Shareholder Level Taxation: US tax compliance
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U.S. Shareholder
• Form 5471
– Category 3
» Certain contributions – situational
» If RPII CFC - annual
– Category 5 – if Captive is a CFC – annual
» Inclusion of Subpart F income
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Form 926 - situational
– Certain contributions
U.S. Officers and Directors
• Form 5471 - situational
– Category 2 – Acquisitions of 10% or more by a U.S. shareholder
Insureds
• Form 720 - quarterly
– excise tax on US risk to foreign insurer
Captive
• ‘protective’ return (optional) - annual
Bermuda Captive 101 –
A Tax Perspective
Bermuda Captive 101 –
A Tax Perspective
Gross Level Taxation: US Federal Excise Tax
Federal Excise Tax IRC §§ 4371- 4373
• 4% on direct premiums
• 1% on life, annuity, health, and reinsurance
• Assessed on premiums ‘paid’
– Any party to the transaction is liable for the tax
• Cascading theory
– Treaty benefit based on residence of (re)insurer
– Rev Rul 2008-15
» US Corp insures risk with ‘treaty-exempt’ Foreign Insurer.
» Foreign Insurer reinsures with ‘non-treaty exempt’ Foreign
Insurer.
» ‘Conduit Agreement’: FET on both transactions
» No ‘conduit agreement’: FET on reinsurance transaction
– Potential impact on captives
» Enforcement issues??
• Not a FIN 48 Issue – FAS 5
Bermuda Captive 101 –
An Actuarial Perspective
Agenda
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Setting up Captive
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Captive Feasibility Help
Type of Captive
Reasons for Captive
Capital Strain
Other Considerations
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Captive Pricing Trends
Bermuda Captive 101 –
An Actuarial Perspective
Captive Feasibility Help
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Quantify costs associated with Company’s proposed program.
(Premium)
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Reinsurance Optimisation (Net Retention)
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Project Liabilities (Reserves)
Bermuda Captive 101 –
An Actuarial Perspective
Captive Feasibility Help
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Business forecast projection at various confidence levels
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What plans are there for the captive i.e. staggered implementation
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What are the potential risks e.g. unexpected losses, volatility shocks
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Pricing / funding / initial reserves of the captive
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Setting economic capital vs statutory capital
Bermuda Captive 101 –
An Actuarial Perspective
Type of Captive
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Pure Captive
– Own prior experience
– Future expectations
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Association Captive / Risk Retention Group
– Pooled Experience
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Agency / Rental / Sponsored Captive (Segregated Cell)
– Pooled Solvency
Bermuda Captive 101 –
An Actuarial Perspective
Reasons for Captive
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Cost Stability
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Less Cyclical Pricing
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Access to Reinsurance
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Better Internal Control
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Improved Cashflow
Bermuda Captive 101 –
An Actuarial Perspective
Capital Strain
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May need more comprehensive reinsurance to start
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Retain larger limits and add more risk as capital builds
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Realistic growth projections
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Careful claims management
Bermuda Captive 101 –
An Actuarial Perspective
Captive Pricing Trends
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Commercial Property – Market Still Soft
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WC – Price Declines but Medical Costs Up
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Professional Liability – High Surplus and Declining Premium
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Medical Malpractice – Frequency Stable but Loss Costs Up
Bermuda’s Captive Regulation
Agenda
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Legislation
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Other Guidance
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Class Structure
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Ratios & Margins
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Statutory Financial Return
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Supervisory Model & Risk-Based Framework
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Regulatory Approach
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International Initiatives
Bermuda’s Captive Regulation
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Insurance Act 1978
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Insurance Accounts Regulations 1980
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Insurance Returns & Solvency Regulations 1980
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Non-Resident Insurance Undertaking Act 1967
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Segregated Accounts Companies Act 2000
Bermuda’s Captive Regulation
Guidance Notes:
20 separate Guidance Notes issued to date:
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Role of service providers
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Market Conduct
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Corporate Governance
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Risk Management and Internal Controls
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Investment Activity
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Investments in Affiliates
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Enhanced Capital
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Special Purpose Insurers
Bermuda’s Captive Regulation
Code of Conduct
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Establishes duties, requirements and standards to be complied with by insurers
including the procedures and sound principles to be observed;
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Application will take into account the insurer’s nature, scale and complexity
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Captive insurers should be mindful of the proportionality principle in
establishing a sound corporate governance, risk management and internal
controls framework.
Bermuda’s Captive Regulation
Classes of General Insurance
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Class 1
- Pure Captives
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Class 2
- Group / Association Captives
- Captives writing less than 20% unrelated business
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Class 3
- Captives writing up to 50% unrelated business
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Class 3A
- Small Commercial Insurers
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Class 3B
- Large Commercial Insurers
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Class 4
- Property Catastrophe / Excess Liability
Bermuda’s Captive Regulation
Other Classes of Insurance
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Long-Term Insurers - Insurer writing long-term business
(annuity or life, some accident and health business)
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Special Purposes Insurers - Insurer fully funds its liabilities
to the persons insured through a debit issuance or some other
approved financing mechanism; cash; or time deposits.
Bermuda’s Captive Regulation
Minimum Solvency Margin requirements
Bermuda’s Captive Regulation
Statutory Financial Return
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Cover Sheet
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Declaration of Statutory Ratios
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Solvency Certificate
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Auditors Report
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Loss Reserve Specialist Opinion
Class 1
Only required if discounting reserves to meet solvency margin or
more than 30% of the business written is professional liability
Class 2
Triennially (unless discounting reserves to meet solvency margin, or
more than 30% of the business written is professional liability)
Class 3
Annually
Bermuda’s Captive Regulation
• Captive vs. Commercial
• Risk-Based Approach
• Role of Principal Representative and Insurance Manager
• Captive Manager On-sites
• Segregated Accounts Companies (Rent-a-Captives).
Bermuda’s Captive Regulation
Pragmatic Approach to Regulation
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“The World’s Risk Capital”
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Creativity and Innovation
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Section 56 Directions
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Modifying accounting regulations
– Approving “relevant assets”
– Admitting assets
– Modifying filing requirements
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Regulations consistent with International Standards but applied
appropriately for Bermuda Market.
Bermuda’s Captive Regulation
International Initiatives:
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Monitoring and Actively Contributing to International Regulatory
Developments
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International Association of Insurance Supervisors (“IAIS”)
– Member of IAIS Executive Committee
– Chair the Reinsurance Transparency Group
– Authority staff are on a total of 13 IAIS Committees
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Solvency II
– Capital Adequacy, Group Supervision, Disclosure & Transparency
– Bermuda seeking Solvency II equivalence
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We believe our captive regime is already in accordance with international
standards, however, we continue to monitor any global developments
relevant to captives and we will adjust our regime accordingly.
Bermuda’s Captive Regulation
WWW.BMA.BM
Bermuda Captive 101
Questions?
• Beverley Todd, Executive Vice President, JLT Insurance Management
(Bermuda) Ltd.
• Neil Horner, Partner and Head of Corporate, Attride-Stirling & Woloniecki
• Scott Slater, Tax Manager, PWC
• Darren Ma, Actuary, PWC
• Leslie Robinson, Assistant Director, Insurance Licensing & Authorization,
Bermuda Monetary Authority