In the aftermath of the COVID-19 pandemic and amid reviews of European directives on anti-tax avoidance, PwC Luxembourg discusses the outlook for the captive insurance industry in Luxembourg
Although one of the smallest sovereign states in Europe, Luxembourg can lay claim to an impressive résumé as a founding member of several leading European and international organisations, including the European Union, the Organisation for Economic Cooperation and Development, the United Nations and the North Atlantic Treaty Organization.
Internationally renowned as a reinsurance hub, Luxembourg is well-positioned as the largest captive reinsurance domicile in the EU. A market segment report by A.M Best last year determined that the captive sector in Europe continued to thrive in hardening market conditions, with European captives demonstrating resilience to the effects of the COVID-19 pandemic.
As companies evaluate the economic rationale for owning and operating a captive in light of directives aimed at anti-tax avoidance and profit shifting, what does this mean for the Grand Duchy?
Partner Géraud de Borman and manager Afif Hamdi of PwC Luxembourg talk to Rebecca Delaney about the landscape of the captive insurance and reinsurance market in Luxembourg, as well as challenges on the horizon.
How do you assess current market conditions for the captive insurance and reinsurance industry in Luxembourg? What trends are you seeing?
Over the last few years, we have been witness to an increase in insurance costs. The pressure on the supply is high and cannot face the demand. Therefore, multinational groups are continuously considering different solutions to insure or reinsure risks at group level that traditional market players can no longer secure.
Naturally, captives have emerged as an alternative solution, either at company level or for pooling several group companies’ risks in the same captive. The broadening of the exposure spectrum of groups, notably with respect to cyber, climate, consumer protection and pandemic risks, have made insurance and reinsurance captives more attractive to multinational groups.
Within the above context, the current market conditions are conducive for the implementation of a captive. In particular, as a pioneer in Europe, in terms of insurance and reinsurance captives, Luxembourg offers an innovative environment both from a regulatory and tax perspective.
How is the regulatory environment of Luxembourg beneficial for captive owners?
Luxembourg implemented a robust and modern legal and regulatory framework for insurance and reinsurance captive vehicles, which are under the supervision of a dedicated regulator, the Commissariat aux Assurances (CAA).
In addition, Luxembourg was a historical frontrunner in the transposition of the 2005 European Reinsurance Directive.
This established the single passport within the EU, allowing a captive under the supervision of its member state of origin to cover risks within the EU without having to apply to other member states for a licence. Indeed, Luxembourg policymakers have played a pioneering role in Europe with respect to captives.
Through their strong understanding of the way captives function, Luxembourg’s policymakers participate in the development of the future European framework for captives, notably in advocating for the recognition of an adapted treatment with Solvency II for captives. In this respect, captive owners in Luxembourg will benefit from a historical knowledge of the speciality of the captive model, managed by the CAA.
We are also seeing that the European regulatory constraints on captives appear to be easing.
The review of the Solvency II directive aims to provide more simplifications and proportionality on captives, underlining the support of the European community in the development of captives in the EU that aim to reduce reporting costs and administrative burdens.
What are the most significant challenges facing the captive industry, in Luxembourg and as a whole?
Even though the accelerating interest in captives can be explained by a number of reasons — including, among others, the disengagement of traditional insurers regarding certain risks, their degree of exposure compared to certain groups, the broadening of the risk profile of multinational groups and significant fee increases — the captive industry still faces several challenges.
The main challenges are the broad diversity and complexity of risks captives need to insure or reinsure.
The complexity of the risks (including cyber, climate and political risks) requires captives to properly understand them, as well as the exposure of the group, in order to accurately catch the underlying risk.
Additionally, the diversity of multinational groups, as well as their specific operating model, requires captives to be fully adaptable to their business activities and determine their risk profile, which adds another level of complexity.
Lately, we have also seen an increasing number of international groups restructuring their operations. As a result, risks are also moving from one country to another, which may be more complex for captives.
Furthermore, in a fast-changing tax environment determined to tackle abusive practices, new European directives may impact the captive industry.
Recently, the European Commission issued two proposals of directives aimed at preventing the misuse of shell companies with no or minimal substance and economic activity (Anti-Tax Avoidance Directive III) and ensuring a global minimum level of taxation of at least 15 per cent for multinational groups in the EU (International Tax Pillar II), whose potential impact on captives may be considered.
How do you expect the landscape of the captive industry in Luxembourg to develop in 2022?
As the market trends show, for the past few years captives have experienced a resurgence of interest.
The number of captives has risen sharply in recent times, reflecting that they are not only used by large multinational groups, but also by a wide range of entities such as non-profit organisations.
The increasing need and interest in captives have been well considered by the EU Commission in the draft proposal of amending the Solvency II directive as dated 22 September 2021, notably ensuring that insurance and reinsurance captives should benefit from the proportionality measures when classified as low-risk profile undertakings.
The tax treatment — in particular, the Luxembourg tax treatment with respect to the deferred tax regime allocated to the equalisation provisions — seems to be better understood by foreign tax authorities.
Questions regarding substance and governance remain a hot topic for tax authorities, and transfer pricing considerations should be analysed more deeply by tax authorities.
Finally, in terms of data, almost 200 reinsurance undertakings are operating in Luxembourg as of year-end 2020.
We have seen a significant increase of this number in 2021 and we are expecting an increase in 2022. In this respect, and within the aforementioned context, we may reasonably expect that the interest in captives will continue to grow in the years to come and Luxembourg will remain one of the main locations within the EU.
