Bermuda: AS&K 'The Brief' - Rent-A-Captives Revisited

Last Updated: 13 May 1997
Bermuda has long been recognised as the domicile of choice for the world's captive insurance industry. One reason for Bermuda's pre-eminence is the success of arrangements which may be structured under its insurance laws, which offer alternatives to more conventional risk management options available in the "traditional markets".

A "captive" is a closely-held insurance company whose insurance business is primarily supplied and controlled by it's owners - in the sense that the owners have and exercise direct involvement and influence over the company's major operations, such as its underwriting, claims management and investment policies - and in which the original insureds are the principal beneficiaries. The "rent-a-captive" represents an evolution of the "captive" insurance company, and has been employed for specialised situations for nearly as long as more standard forms of captives have been operated.

A rent-a-captive programme can be structured so that effectively unrelated parties may participate in the underwriting profits generated by the risks which they insure (or arrange to insure) via the captive. In addition, rent-a-captive policyholders (or owners of such policyholders) may be negotiation secure a significant degree of influence over both the investment of underwriting reserves maintained by the captive in respect of the programmes with which they are associated, and control the rate of the "flow of funds" through the captive (in the sense of the timing of permitted distributions). Such advantages over traditional insurance arrangements have long been the hallmark of the rent-a-captive, and in recent years innovations in Bermuda insurance laws have extended the options for structuring rent-a-captives, leading to a resurgence of interest in their use.

WHAT IS RENT-A-CAPTIVE?

A rent-a-captive is a company, typically established in an off-shore domicile like Bermuda, which "rents" its capital, surplus and legal capacity to engage in underwriting activities (i.e. its insurance licence) to policyholders which are not its voting shareholders. The rent-a-captive will often provide its policyholders ("programme participants") with required administrative services. As such, the term "rent-a-captive" applies to any arrangement where the insured party obtains equivalent benefits to those provided by standard forms of captives without actually participating in ownership or management.

One of the principal characteristics of a rent-a-captive is that the account established for each programme participant is segregated in some manner from accounts established for other programme participants. This is done to achieve a separate accounting basis for the insurance business attributable to each programme participant. Such segregation may be accomplished administratively by the rent-a-captive itself, or there may be a full legal segregation which results in statutory protection from losses attributable to other programme participants.

ADVANTAGES OF A RENT-A-CAPTIVE

Rent-a-captive programmes have long been acknowledged as alternatives to commercial insurance which offer more cost-effective and flexible risk management solutions, particularly with regard to workmen's compensation, but also for general liability programmes.

A rent-a-captive programme offers programme participants many of the advantages of a wholly-owned captive without requiring the insured party (or its owners) to make an equivalent commitment to fund the captive's start-up and ongoing management expenses. These advantages include the facility to customise the insurance programmes and control premiums, pricing and access to re-insurance. Establishment of the rent-a-captive in a select domicile (e.g. Bermuda) results in favourable (yet responsible) governmental regulation. Additionally the rent-a-captive can often secure coverage for specialised risk when this is unavailable in the commercial insurance markets. However, the main advantage of rent-a-captive may lie in enabling the programme participants to obtain a return of underwriting profit and investment income earned on the reserves held in their respective insurance programmes. Such returns will of course depend on the loss experience of the particular case.

Typically, each programme participant will retain a portion of its own risks, insuring the balance with the rent-a-captive. This arrangement creates powerful incentives to programme participants to be proactive with loss control and claims handling measures. Such measures will often be co-ordinated by agreement between the programme participant and the rent-a-captive, and perhaps with professional claims handling service providers.

OWNERSHIP AND CORPORATE STRUCTURE

There are various ways to own and structure a rent-a-captive, depending on whether the proposed programme participants are single corporations or a group or association. There may be tax and other factors to consider, from the standpoint of both the proposed programme participants and the sponsors of the rent-a-captive.

One of the more common rent-a-captive structures involves the sponsors forming a Holding Company which owns 100% of the voting shares of a Re-insurance Subsidiary. The Re-insurance Subsidiary in turn re-insures each programme participant., in association with an Issuing Carrier which issues the policies of insurance to the programme participants. The Issuing Carrier will usually be an insurance company which is licensed in the jurisdiction(s) in which the programme participants are resident. The programme participant will be afforded access to the rent-a-captive programme when it arranges for a policy to be issued by the Issuing Carrier and, in association with this, it will purchase one or more preferred non-voting shares in the Holding Company. Such shares will be purchased pursuant to the provisions of a shareholder agreement wherein the rent-a-captive agrees to cause a dividend to be declares to the owner of record of the preferred shares. Dividend payments will also be controlled by the shareholder agreement, e.g. on a date indicated on the appendix, being an annual payment date or the termination date of the particular programme. Dividends will be calculated according to a specific formula involving investment income earned and underwriting gain r loss. Payment of dividends will be subject to the availability of surplus funds (i.e. surplus of the statutory reserve requirements) in the related account.

The shareholder agreement will provide for indemnification of both the Holding Company and Re-insurance Subsidiary by the programme participant, the indemnity being designed to protect these entities in respect of any net underwriting losses, loss expenses and collateralisation expenses arising from the related insurance programme. As collateral for this indemnity, the programme participant will usually agree to provide the Re-insurance Subsidiary with a letter of credit (or substitute cash collateral).

The shareholder agreement will also provide for the payment by the programme participant of all premiums due to the rent-a-captive. Failure will constitute a material breach of the agreement. The amount of any such non-payment, together with interest, may be deducted from any surplus reserves held for the account of the particular programme, or any dividend due to the programme participant.

Dividends on the preferred shares issued to each programme participant will be declared and paid separately, i.e. as a separate class or series. Such shares will also be redeemable at face value upon the termination of a programme. However, where the capital required for the particular programme has been "rented" from the rent-a-captive, the shares will be redeemed less financing costs.

In other cases, the structure may not involve a holding company, leaving a re-insurance company which stands alone as the rent-a-captive. In such an arrangement, it will be this stand-alone re-insurance company which issues the preferred shares and enters into the shareholder agreement with the programme participant.

A growing number of rent-a-captives utilise a private Act of the Bermuda legislature, so that they may achieve legal segregation of the assets and liabilities of each insurance programme which they underwrite, so that there is no potential for "cross-liability" of one such programme resulting from the experience of another. Where the rent-a-captive is so structured (and depending upon the precise language of the private Act), the complete segregation of each programme participant's account can be achieved, the assets for each programme participant being isolated and protected from the liabilities of other programme participants and the failure of the rent-a-captive itself.

The advantages of such a structure will be clear. Pursuant to the typical provisions of such a private Act, a liquidator is as a matter of law bound to recognise the separate nature of the segregated account established for each programme, and may not apply assets of any one programme to pay claims of insureds under other policies issued by the rent-a-captive's non-insurance creditors. In addition, the liquidator typically has no power to void or cancel the terms of any policy, deed or contract issued in respect of any programme.

Not all rent-a-captives will be structured to take the benefits afforded by a private Act of this kind. Some rent-a-captive owners take the view that their programme participants may not be able to deduct premiums for tax purposes if there is demonstrably less risk-sharing among programme participants.

HOW DOES THE RENT-A-CAPTIVE WORK?

In the typical scenario, the programme participant (either on its own or with the assistance of a broker or the rent-a-captive or both) will negotiate with the Issuing Carrier, which will be an admitted insurance company (or "fronting" company) for the provision of policy-issuing and related services. The fronting company will then issue policy and cede the working layer to the rent-a-captive. For this service, the fronting company charges a fee, which may range anywhere from 5%-14% of gross premium. The fronting company will also be required to deduct certain federal and/or state taxes. As a matter of law, the fronting company will be primarily liable for the risk. However, the re-insurance agreement with the rent-a-captive will invariably require the latter to provide the fronting company with a clean, irrevocable letter of credit. The letter of credit is ultimately paid for and backed by the programme participant., typically as a one-time charge of 0.5% of premium, or as an annual fee of 0.375% of the premium deducted from the dividend. The guarantee for the letter of credit is the programme participant's own funds held by the rent-a-captive. In addition, the rent-a-captive itself will charge an underwriting fee of perhaps 2%-3.5% of premium.

CAPITAL REQUIREMENTS

In order to meet the Bermuda premium underwriting requirements (i.e. the ratio of premium to capital and surplus), a programme participant must itself either provide or "rent" the necessary capital. If the programme participant elects to rent, the rent-a-captive will often supply such funds from its own common share capital (usually for a fee of 1%).

Where capital is provided by the programme participant, this is generally accomplished through the purchase of the rent-a-captive's preferred non-voting shares, in an amount equal to 1/5th of the first year's net premium.

Purchasing the shares achieves two purposes. First, it provides the rent-a-captive with adequate capital for regulatory purposes. Second, as ownership of the shares constitutes beneficial ownership of the rent-a-captive, it may provide a basis for the taxable transfer of income back to the programme participant through deemed dividends.

RENT-A-CAPTIVE ACCOUNT EXPENSES

Rent-a-captive account expenses are typically 25%-35% of original gross premium ("OGP"), although they can be higher. These include boards, bureau's, taxes and assessments (3%-4%), claims handling (3%-4%), onshore broker commission (4%-5%), federal excise tax (1%), cost of specific excess (3%-6%), cost of aggregate excess (2.5%-4%), fronting company fees (5%-9%),rent-a-captive's capital and surplus, where applicable (1%).

What is left after fees and commissions (generally 60%-70% of OGP) and loss reserves may be temporarily available to the programme participant. Meanwhile, the rent-a-captive will invest these funds (typically though a professional investment adviser in order to maximise investment portfolio performance) and return investment income to the programme participant through dividends on the preferred shares, less a service income fee to the rent-a-captive (generally 1% of the value of the portfolio).

Provided that the rent-a-captive complies with applicable minimum solvency and liquidity ratio requirements (or, if there are segregated accounts pursuant to a private Act, where each programme for which a separate account is maintained complies with such requirements), Bermuda law permits complete freedom of investment management with regard to selection of asset classes.

PROFILE OF A PROSPECTIVE PROGRAMME PARTICIPANT

A prospective programme participant will generally:

  • be too small for, or not interested in, establishing and operating a wholly-owned captive for itself; and
  • generate at least $750,000 of annual premium onshore (be it a single-owner or association programme of insurance). (Workers' compensation programmes in California, which may be underwritten with less premium, are an exception to this).

In the case of association programmes (which are thought to account for about one third of total rent-a-captive premium income in the Bermuda market), association members are typically characterised by:

  • similar exposures;
  • a willingness to share risk within the mutual account;
  • a combined loss ratio of 50% or less;
  • a single or related exposure such as workers' compensation, general liability or automobile liability; and
  • a consensus on the allocation of underwriting profit and investment income.

DOES THE RENT-A-CAPTIVE ITSELF ASSUME RISK?

Many of the rent-a-captives formed in Bermuda do not assume substantial risk in respect to the insurance programmes of their programme participants. Rather, these rent-a-captives view themselves as service companies and in fact require aggregate excess protection in some form as a condition of accepting a particular programme. All financial agreements are typically backed up with letters of credit ultimately guaranteed and paid for by the programme participant.

In recent years, the Registrar of Companies of Bermuda has made it clear that his office is prepared to consider applications to establish rent-a-captive which will accept risk for their own account, subject always to meeting relevant solvency and liquidity requirements.

The insurance team of Appleby, Spurling & Kempe has been actively contributing to the growth of Bermuda's dynamic international insurance industry by our involvement in formulating and recommending changes to relevant legislation and advising on innovative corporate structures. Our Insurance Team is the largest practice area within the firm and comprises ten corporate attorneys practising almost exclusively in the insurance fields and twelve full-time dedicated corporate administrators. Should you wish to find out more about CATEX Bermuda, please contact Warren Cabral, Head of the Insurance Team, using the telephone or facsimile number or e-mail address printed on the first page.

The Insurance Team Attorneys of Appleby, Spurling & Kempe are:

Warren Cabral (Head)
F.  Chesley White (Deputy)
John D. Campbell Q.C. (Senior Partner)
Richard D. Spurling
Kenneth E.T. Robinson
Douglas H. Molyneux
Michael J. Burns
Timothy C. Faries
Gigi Barit
Brian J. Patterson
The insurance Team Corporate Administrators of Appleby, Spurling & Kempe and their secretaries are:

Insurance Team I

Cheryl S. Harney (Corporate Group Manager)
Peggy A. Tucker (Deputy)
Nicola J. Backeberg
Michelle F. Smith
Jill D. Paynter
Kevamae Sampson - Team Secretary
Tonita S. Eversley - Team Secretary
Marcia Gillbert - Team Secretary

Insurance Team II

Audrey M. Mansell (Corporate Group Manager)
Judy Taylor (Deputy)
Cilma A. Lamb
Shari L. Simons
Stacy Grant
Dionne G. Hackett - Team Secretary
Marcia Gilbert - Team Secretary

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions