Under the watchful eye of insurance regulator the Commissariat Aux Assurances (CAA), Luxembourg has become the largest captive reinsurance domicile in the EU, with nearly 250 approved reinsurance companies, of which the majority are captives. Luxembourg passed its first captive reinsurance law in 1984, with an amendment made in 2007 to transpose the EU Reinsurance Directive into national law.
Under the watchful eye of insurance regulator the Commissariat Aux Assurances (CAA), Luxembourg has become the largest captive reinsurance domicile in the EU, with nearly 250 approved reinsurance companies, of which the majority are captives. Luxembourg passed its first captive reinsurance law in 1984, with an amendment made in 2007 to transpose the EU Reinsurance Directive into national law.
This legislation has evolved to require that reinsurance companies collect adequate technical and balancing reserves. It allows captives with less favourable risk diversification to build large technical reserves to cover these risks.
For both life and general insurance, captive insurance companies, like any Luxembourg commercial company, are liable to pay corporate income tax at a rate of 21.8 percent and a municipal business tax at a rate of 6.75 percent in Luxembourg City (overall tax rate: 28.59 percent). Auditing firm PricewaterhouseCoopers notes that “a reinsurance company can benefit from a deferral of taxation”—a loophole that is no doubt appreciated by those in the sector.
Setting up shop in Luxembourg comes with a pricetag. For an insurance captive, a minimum guarantee fund of €2.3 million or €3.5 million, depending on the risk category that is insured, is required. For a reinsurance captive, the numbers skew slightly lower—€1.23 million or €3.2 million, depending on whether it is a professional reinsurance undertaking.
Though the European insurance market has exhibited fairly regular growth in premiums, coverage requirements have deteriorated for companies having to deal with high volatility in premiums, difficulty in finding cover that is adapted to the risks resulting from their activities, insurers’ refusal to cover some risk areas, and market capacity constraints.
Companies looking for alternative solutions to control and finance their risks are slowly coming around to the idea of captives, although regulation still remains an issue.
While captive owners and managers are by and large sympathetic to the prospect of new insurance legislation replacing Europe’s current 14 capital adequacy and risk management directives, the industry is still waiting for a moment of lucidity on exact requirements for Solvency II. Solvency II remains among the biggest hurdles for captives ahead of the directive’s scheduled introduction at the beginning of 2014, and could be a stumbling block for Luxembourg.
Solvency II may swell regulatory capital requirements for EU’s captives by up to 400 percent. The new rules could also affect regulatory equivalence. In the EU, captives in one domicile are allowed to be admitted into another within the EU. However, under the proposed Solvency II rules, it is not yet clear if a captive that is owned by an EU business or association, but domiciled outside of the EU, will have regulatory equivalence.
“As the compulsory equalisation reserve ranks as first tier capital under Solvency II, Luxembourg is not feeling the strains as much as some domiciles,” says Sophie Vandeven, business development manager for Aon Insurance Managers Luxembourg. “Solvency II remains a challenge however, be it only at an operational level.”
The creation of an equalisation provision was set in place in December 2007 by Luxembourg’s Grand Ducal, with the aim of covering exceptional claims that may occur and are tax-deductible. The CAA establishes individual coefficients and attaches them to each risk category, with ratios set up at six times the standard deviation of the “loss premium” ratio recorded for a given risk.
This is just one of the ways in which Luxembourg lawmakers are helpful when it comes to captives. Since 1984, when the country set up a legal, tax and regulatory framework for reinsurance companies that helped reinsurance captives to bloom, the sector has been doing as much as possible to make sure that it remains one of Europe’s leaders. “Luxembourg lawmakers are naturally conservative in their outlook, but are keeping, as much as possible, a pragmatic market approach,” says Vandeven. “Control authorities are also very happy to set time aside to meet potential captive owners interested in forming a Luxembourg captive.”
Though many lines are written through captives in Luxembourg, employee benefits and life reinsurance are becoming popular, and the country has set itself up as a good spot for reinsurance captives. “Luxembourg has a unique position within the EU, with the compulsory equalisation reserve as a major asset,” explains Vandeven. “This enables reinsurance companies to set up large fiscally efficient catastrophe claims reserves.”
Looking outwards beyond the country, European captives are remaining strong, with the Insurance Information Institute (III) predicting more captive formations moving onshore into the US and Europe. In an update to its research of alternative risk vehicles, III revealed more than half of captive formations in 2011 were located within the EU and the US, increasing the total of onshore domiciles from 35 percent in 1991. In Europe, Guernsey was the largest domicile with 343 captives in 2011, with Luxembourg coming second with 242, followed by the Isle of Man (133), Dublin (101) and Sweden (49).
On how Luxembourg’s captive offering may be advantageous over offshore jurisdictions, Vandeven says: “It’s the compulsory reserving that makes Luxembourg stand out over its competing jurisdictions, be they offshore or not. This, along with having 64 tax treaties in place and a further 22 pending, means that we are a well-respected financial centre. Traditional values such as regulatory stability and accessibility should not be underestimated.”
Other domiciles that may present future competition “depend on the client’s goal on the short and medium term,” states Vandeven. “Luxembourg is more oriented towards setting up a strategic insurance and reinsurance management tool for the group, with strong position towards market, thanks to the equalisation reserve.”
