26-May-2014

Cayman and Canada: A Perfect Partnership

Kay Carter and Paul Arbo

This article was published in Captive Review.  Download the pdf here.

Kay Carter of Solomon Harris and Paul Arbo of BDO explain what the Cayman Islands can offer Canadian businesses and why they should establish their captives there

Bios:

Kay Carter is a senior associate with Solomon Harris in the Cayman Islands.  Prior to joining Solomon Harris in 2009, Kay practised tax and natural resource law in Canada.  Since joining Solomon Harris, Kay has focused on offshore corporate commercial and trust work, with particular emphasis on business restructuring and reorganisations that provide practical, cost-effective solutions for clients. 

Paul Arbo, CA, ACI, is a partner with the firm of BDO in the Cayman Islands and signs off on over seventy insurance audits annually.  Paul also holds an ACI (Associate in Captive Insurance) designation from the International Center for Captive Insurance Education, a widely-regarded certification within the industry.

Captive Review (CR): What Canadian based industries/lines of business do you think might be best suited for a captive solution? 

Kay Carter (KC): In my view, the businesses have to be large enough to be able to self-insure and profitable enough to make it advantageous to use a tax neutral jurisdiction to earn income on premiums that their claims experience would indicate will likely not be needed to pay claims.  The line or type of business is really not relevant as long as the type of business has some aspects that need to be insured.  Cayman segregated portfolio companies (SPC) can be used effectively for group captives.  Most group captives are formed to provide insurance for entities that are engaged in the same or similar businesses (the key is that there be some common aspect to insure) who might not be large enough to be able to set up their own captive.  A group of entities will own the core of the SPC while individual members of the group will own their own segregated portfolio (cell).  Under Cayman law, the assets and liabilities of each cell are segregated from other cells and the core of the SPC, which is often referred to as “ring fencing”.  As a result, creditors (or insureds) of one cell cannot access assets of another cell to satisfy claims.

Cayman has recently enhanced the attraction of SPCs by providing that a cell may create a company to carry on its insurance business.  A portfolio insurance company, or PIC, is a separate legal entity from the SPC which reinforces the legal segregation of assets and liabilities that belong to a PIC from the assets and liabilities of other cells, PICs or the core of the SPC.  Group captives can be viewed as an “entry level” way to set up a captive and is a cost-effective way to determine whether a captive will work for a Canadian business.   

Paul Arbo (PA): As the traditional insurance market in Canada has not been as volatile as the United States in recent times, the opportunities for using captives are not quite as common. This is in part due to Canada’s stable economy, which withstood - and recovered quickly from – the latest recession better than the majority of countries around the globe.

The less litigious environment in Canada is another differentiator between the traditional insurance markets in the two countries. Another key consideration is the universal healthcare and workers compensation programmes which exist in Canada. These lines of insurance are common in Cayman captive structures and even more so now with the onset of Obamacare in the US. Many of the captive insurance companies which we see in Cayman cover risks in the US which are either uninsurable in the eyes of traditional insurers or are seen as being so risky that they attract extremely high premiums. In these instances, a captive insurance structure is seen as a necessity by the client.

The cost/benefit bar is set considerably higher when the feasibility of a captive structure is being considered to cover Canada-based risks. However, there are still a number of good reasons for Canadian businesses to explore captive insurance solutions. I would say that large businesses and some medium-sized companies in heavier industries are best suited for a captive solution and I know that shipping and oil and gas companies have been using captives for a number of years to cover their considerable risks

I feel that Canadian companies would be well-served to look at the US and other insurance markets for examples of more innovative uses; terrorism threats and various environmental pollution risks are being successfully self-insured through captives now. Warranty risk and premium healthcare coverage have also worked well within a Cayman captive and I would think there are opportunities in the Canadian context as well.

CR: What advantages might the creation of captives offer Canadian businesses?  

PA: The retention of earnings on the invested premiums paid into the captive, the higher incentive to cut the cost of claims (and hence more attention paid to claims control and risk management programs), the higher degree of flexibility when structuring coverages, the increased access to reinsurance markets, the opportunity for pooling risks from various business units, asset protection and certain tax deferral benefits are all recognised as significant advantages of captive structures. The only significant variations, as discussed above, are the regulatory regimes and business environments (both general and industry-specific) which can influence the benefits that are available.

KC: Captives have traditionally been used in areas where the underlying business wishes to generate income in a tax neutral jurisdiction.  The oil and gas industry not only uses insurance captives, but uses other offshore companies to carry on business outside of the country where the primary business is located.  For example, oil and gas service industries have used offshore corporations to provide transportation services or lease equipment for use outside their home country.  When offshore jurisdictions are properly used, taxable businesses can control the taxes that might be imposed by another jurisdiction or even reduce their overall effective tax rate by earning income in jurisdictions with lower tax rates.  There have been examples in the news from time to time (e.g. Apple).  Canadian businesses aren’t any different than US businesses in needing to improve the bottom line whether by increasing revenues or trimming costs.

Even though Canada has universal healthcare, there are areas where secondary healthcare insurance is useful or desirable.  All of the provinces are experiencing cost issues with healthcare, so there is an increasing drive to privatise at least some aspects of healthcare.  In Alberta, there are private clinics that provide surgery, cataract or carpal tunnel surgery, for example.  This development has made more time available in hospital ORs for more complicated surgeries.  As the baby boomers age, the pressure on medical facilities and the cost of providing medical services will only increase.  As a result, secondary health care insurance may become a larger industry.    

CR: Why is Cayman so well suited for a Canadian parented captive?

KC: The Cayman Islands has a world class service industry so the captives and their parents are able to draw on legal, accounting, financial and management services that are comparable to that which are available in Canada, the US or Europe.  I have been consistently impressed with the expertise and professionalism of not only my legal colleagues in the Cayman Islands, but the professionals in other areas that I have worked with.  Chambers Global annually evaluates the quality of lawyers worldwide, and several lawyers in the Cayman Islands (including several in my firm) are consistently ranked very highly.  In addition to the service providers, the Cayman Islands Monetary Authority (CIMA) does an amazing job of regulating insurance businesses while at the same time being very responsive to the needs of Cayman captives.  CIMA is very involved with the owners of captives and the managers of the captives and goes out of its way to ensure that time deadlines are met and any business issues are sorted out to everyone’s satisfaction.  They have managed to strike an exceptional balance between regulation and being responsive to businesses.  Lastly, from the perspective of a Canadian parent, a subsidiary engaged in an active business in or from the Cayman Islands can pay dividends as exempt surplus to the Canadian parent without triggering Canadian tax.  This tax benefit results from the fact that the Cayman Islands entered into a Tax Information Exchange Agreement with Canada in 2010 which came into force on 1 June 2011. 

PA: As an auditor of almost 70 captives I am in a great position to observe all aspects of a captive insurance company’s operations. I have lived and worked in the Cayman Islands for over eight years now and I am continually impressed by the professionalism and co-operation amongst the insurance managers, lawyers, bankers and investment managers, insurance brokers, actuaries and claims managers upon whom we rely during the performance of the annual audit.

Furthermore, the regulatory regime in Cayman is second-to-none in terms of its ingenuity and willingness to listen to and work with captive owners and industry leaders in Cayman in order to innovate while striking a balance between keeping a watchful eye but not interfering or setting undue roadblocks. Recent tax information sharing agreements between the Caymanian and Canadian government have put the Cayman Islands on more of an equal footing with other jurisdictions which historically have had a monopoly on the Canadian market. This, of course, is good news to Cayman but also good news for Canadian companies looking for more destinations to domicile captives.

CR: How have recent changes in the regulatory landscape impacted upon the Canadian captives market? 

KC: The ability given to SPCs to create and use PICs which are covered by the insurer’s licence of the SPC should be of interest to Canadian businesses as it makes the use of group captives even more attractive.  Since a PIC is a separate legal entity, the segregation of liabilities and assets between cells, between PICs and between the cells and the core is based on common law and not just on legislation in the Cayman Islands.  The legislation providing for PICs has been passed, but enactment is pending as the PIC regulations have not yet been adopted.  The regulations have been unfortunately delayed due to some staffing issues at CIMA, but we are hopeful that they will be released soon.

PA: The tax information sharing agreement has helped improve certain perceptions about the legitimacy of doing business in Cayman. The new marketing strategy of the Insurance Managers Association of Cayman (IMAC) - “Clearly Better Business” - is both a subtle reference to the transparency of Cayman’s business climate, as well as a not-so-subtle reference to the quality of our regulatory environment, infrastructure of professionals and other resources here. This transparency may come as a surprise to many given the Island’s vilification in parts of the press and on television and film in the past few years, but I can assure you that the reality is much more mundane.

The new Insurance Law which came into force during the latter part of 2012 introduced several changes that have improved the overall product which Cayman offers, while also recognising separate classes of insurance licenses for reinsurers and insurance-linked securities products. The work done by Kay and her colleagues at Solomon Harris on the impending portfolio insurance company (PIC) legislation will offer additional benefits and flexibility than what is currently offered by the segregated portfolio company structure.

CR: What are the main considerations a prospective owner needs to make before committing to a captive?

PA: Prospective owners should always undertake an open and earnest feasibility review to ensure that a captive structure can achieve the goals which they have identified and to complement their existing risk management tools. The business case for establishing a captive insurance company may be a tougher one to make for Canadian companies and it should be an option considered with the help of experienced industry professionals.

The commitment to a captive structure must be a long-term one in order to access the true benefits available. Captive insurance is not about trying to capitalise on a short-term window of opportunity to turn a profit and, while the tax benefits available in certain jurisdictions are more attractive than in others, it is important to not place too much emphasis on this aspect of the decision at the expense of flexible and reasonable regulation; the political, economic and social stability of a jurisdiction; and, most importantly, a solid business reason for setting up a captive.

KC: A feasibility study should be done to provide information regarding whether and to what extent the business can support self-insurance.  A feasibility study should include a cost/benefit analysis based on historic claims experience.  Since there is always a cost to setting up a system within a business, the prospective owner should commit to using a captive for a number of years to spread costs and perhaps adverse claims experience over time.  At that point, the benefit of continuing to use a captive could be evaluated.

CR: When does it make sense to think about a captive for a business?

PA: My general rule is that if your annual insurance spend is over $500,000, your loss history is consistently good, and if you are underwhelmed by the insurance coverages you currently have in place, then you may be a good candidate to consider a captive. That said, try to be very discerning of the existing insurance programs in place and avoid taking too much comfort in the status-quo of your existing insurance programs which maybe “working” satisfactory.

KC: A business should do a cost/benefit analysis to determine whether a captive could enhance its bottom line.  As Paul mentions, a business should also consider having its insurance programme reviewed by an insurance professional to see if there are opportunities that have been overlooked.

CR: What plans does your business have for Canada in the next 12 months?  

KC: My firm is supporting my endeavours to develop a greater interest in Cayman captives as well as other legal services that can be provided for Canadians in the Cayman Islands.  As part of that business development, I will be located in Calgary for the next 12 months.

PA: I have seen a spike in the amount of captives that we audit which cover risks in the Canadian market and I have been encouraged by news that Cayman is being considered more seriously by potential Canadian captive owners. However, in order to increase the profile of Cayman as a captive insurance domicile greater education and understanding is still required. I am hopeful that all of us service providers in Cayman can band together with IMAC and the likes of Cayman Finance and make a concerted effort to show Canadian producers and potential captive owners how we differentiate from other jurisdictions.

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