Captive Management in Luxembourg
| Luxembourg’s Captive Reinsurance Rules
| The Equalisation reserving Rules
Captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they often also insure risks of the group's customers as well. Using a captive insurer is a risk management technique, by which a business forms its own insurance company subsidiary to finance its retained losses in a formal structure.
A captive can present commercial, economic and fiscal advantages to their owners resulting from the reduction in risk management costs. This will enable a business to provide a cover more suited to their needs than policies available on the traditional insurance market or alternatively not available on the market whatsoever - essentially bespoke Risk Management. Couple with this the ability to build up and set reserves assists in risk transfer management.
In almost every case, captives are formed because of a general dissatisfaction with existing risk and insurance coverage or costs. A financial institution may need to cover its transfer agency for failed or delayed trades under an Error & Omissions line (Operational Risk), Directors & Officers or, considering the current market turmoil, a credit policy but find prices quoted on the traditional market prohibitively costly. Such coverage can be underwritten through a captive.
Advantages of utilising a captive in professional risk management
- Reduced overall cost of risk
- Avoid frictional risk charged costs (risk premium, insurance company overheads & profit)
- Participate in insurance profits
- Avoid embedded reinsurance cost (insurance company reinsurance cost)
- Cash flow management – premium payments matched to group flows
- Potential tax benefits – deferral using compulsory catastrophe reserves
- Cash flow benefits – parent loan back
- Decreased vulnerability to market history & cycles – avoid aggregation/risk pooling
- Customised insurance programmes – insurable risks, with or without a claims history - flexibility.
- Coverage for non-insurable risks – market refusal, lower corporate deductibles.
- Claims control & handling – time between claim made to claim paid.
- Loss reserving – reserving in non insurance/reinsurance accounts is not tax deductible.
Captive Management in Luxembourg
The Luxembourg financial centre provides the ideal legal framework and administrative infrastructure for captive reinsurance solutions.
With over 240 licensed reinsurance undertakings, most of which are captive companies, Luxembourg has become the largest domicile for reinsurance captives in the European Union and one of the largest in the world.
A number of factors underpin the choice of Luxembourg as a domicile:
- Luxembourg is a globally recognised financial centre in an EU/OECD member state;
- It has a strong regulatory environment;
- Economic, social and political stability ensure a secure legal and tax framework;
- There is an attractive legal framework for captive reinsurance companies;
- Luxembourg’s unique multilingual and multicultural workforce is accustomed to working in different jurisdictions and time zones.
Luxembourg’s Captive Reinsurance Rules
- Compels the establishment by each entity of a large catastrophe/equalisation reserve.
- Until maximum catastrophe/equalisation reserve is reached, taxation is only levied on capital – Conservative approach to Risk Management .
- Single Reinsurance License covers non life & life business.
- Captive Reinsurance Company exit mechanisms available – disposal market.
- Headline tax rate is high, though reinsurance companies must utilise maximum equalisation reserve first - No Stamp Duty.
- Flexible investment rules/excess cash & parent treasury & lend back.
- Solvency margin as per EU Reinsurance Directive.
- Euro € is the national currency / may follow the parent company
The Equalisation Reserving Rules
- Maximum Equalisation provision = sum (per risk category) of (average of retained earned premiums over last 5 years X actuarially assessed multiple).
- If Equalization provision is less than 30% of its maximum, all technical results and financial results must be allocated to the Equalization provision.
- If Equalization provision is exceeding 30% of its maximum, all the technical result and only a part of the financial results is to be allocated to the Equalization provision.
- Realized or unrealized capital gains and losses on shares in affiliated or related companies must not be taken into consideration in the financial result to allocate to the Equalization provision.