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CAPTIVE INSURANCE may be possible to create a captive in one domicile and then transfer to another subsequently more-advantageous domicile. Issues to Consider in Selecting a Domicile On-shore (domestic, such as Vermontbased) and offshore (international, such as Bermuda-based) domiciles each have different characteristics. These characteristics are at the heart of the basis for domicile selection. The decision of where to domicile a captive generally depends upon an organization's prioritization of these domiciles' characteristics and their relative advantages and disadvantages. A decision on domicile should be based on the parent company's overall risk-management objectives, the international nature and distribution of business operations, including mining and milling locations, and the ultimate objectives it wishes the captive to pursue. Factors relating to domicile choice include: • Regulatory environment • Organization/operation costs • Investment restrictions • Capitalization and reserve requirements • Restrictions on use of any surplus(es) • Taxes (premium tax, federal excise tax, etc.) • The types of coverage to be offered Important Considerations Involving the Regulatory Environment The most important benefit of non-U.S. domiciles is their flexible regulatory environment. An offshore captive generally provides more flexibility on the type of business it can "write;" i.e., the types of risks that can be managed or insured against. Once a captive is formed in Bermuda, for example, it is, in practice, subject to relatively limited ongoing regulation. No specific prior approvals are needed to make changes to a captive's business plan, although Bermuda does exercise certain oversight regulations. Also, Bermuda must initially approve a captive's business operations profile and a business plan of a proposed captive must pass the scrutiny of various regulatory committees. On-shore captives in Vermont generally are regulated more closely than their offshore counterparts and must operate entirely within the confines of the specific elements of a filed business plan. However, these required business plans can be altered relatively easily with the cooperation and approval of the domicile's regulators. Incorporation and Operation Costs As set forth above, the formation and oper38 E&MJ; • FEBRUARY 2013 ation of a captive generally entails various expenses, including the following: • Organizational costs • Actuarial fees • Management fees • Legal fees • Audit fees • Premium taxes Regulatory requirements dictate that records must be kept and transactions must take place within the captive domicile. Generally, however, the management of captive insurance companies is outsourced to a dedicated professional insurance broker affiliate or independent management firm with experience and resources in that domicile. Generally, overall organizational (and first year of operation) fees and costs can range from about $30,000 to more than $100,000 depending upon the complexity of the captive's program. Investment Restrictions and Capitalization Requirements Restrictions on the types of permissible investments by a captive exist in most jurisdictions and each jurisdictions' rules must be examined as part of the feasibility study. Similarly, capital requirements for a newly formed captive can vary widely between jurisdictions from less than $150,000 to more than $1 million, depending upon various factors including the proposed scope of coverage offered by a captive and the nature and relationships between and among the various insured entities. The Financial Value The use of a captive can, by virtue of its taxation under the regime applicable to insurance companies in the U.S. Federal tax code, result in additional savings, which dramatically reduce the cost of coverage. This makes captives very attractive in many business settings, but generally is less of a factor in mining given the potential for losses. Under a basic, fully selfinsured arrangement, a company would recognize losses paid out over time as a year-to-year tax deduction. For example, Worker's Compensation losses which occur within one underwriting period might be paid out over a period of eight to ten years. As such losses are paid out, however, the tax deduction may be taken, or is recognized, in the financial period during which the expense is actually incurred. On the other hand, under a captive arrangement, premiums are paid on a prospective basis and are arrived at by calculating the ultimate-loss cost associated with the events assumed to be occurring in any given year (i.e., the total losses associated with the events), in addition to other expenses, such as premium taxes and the captive's operating costs. Should the payment of premiums into the captive demonstrate sufficiently proper elements of insurance under existing U.S. Internal Revenue Service rules, then the captive premium could be recognized as a tax deductible expense by the policyholder payor in the current period, just like a premium paid to a commercial carrier. On the other hand, the captive is able to establish deductible insurance loss reserves against a significant portion of premium received (since the captive is structured as, and is in fact treated under the tax code as, a true insurance company) in the current period for layers of assumed risk. The net result potentially enhances cash flow and reduces overall taxable income for the captive and, therefore, its corporate owners reporting on a consolidated basis. Tax Issues in Choice of Foreign Domicile Because insurance companies domiciled in Bermuda are deemed foreign insurance companies when it comes to U.S. policyholders, there is a U.S. federal excise tax of 1% on gross ceded reinsurance and 4% on direct property and casualty premiums. If the premiums paid by the policyholder to its captive are not treated as insurance premiums for U.S. federal taxation purposes, they would be exempt from this U.S. federal excise tax. One alternative that may allow a U.S. parent to avoid federal excise tax is for the off-shore captive to take the 953(d) Election of the U.S. Tax Code. This election allows foreign insurance companies to be treated as U.S. taxpayers. Some of the more important concerns for a parent company to consider in this regard include: www.e-mj.com