For an onshore district that is home to all three branches of the US federal government—congress, the presidency and the supreme court—it would be fair to say that captives in the District of Columbia must watch their step carefully.
For an onshore district that is home to all three branches of the US federal government—congress, the presidency and the supreme court—it would be fair to say that captives in the District of Columbia must watch their step carefully.
Despite this, the District of Columbia has managed to come up with advantageous legislation that makes it a competitive domicile. In comparing the district’s captive capital requirements with those of Bermuda and the US State of Vermont, the district clearly allows for less restrictive capital requirements.
Bermuda’s capital requirements are $120,000 for Class 1 (pure captives), while Vermont charges $250,000 for the same type. The District of Columbia has the comparatively lower price of $100,000.
The District of Columbia also encourages the formation of captives with larger premium writings and direct insurance instead of reinsurance. Tax incentives serve to position it as an ideal domicile for businesses seeking to write their own insurance programmes and purchase reinsurance protection from reinsurers.
Arthur Perchetz, counsel at Washington DC law firm Baker & Daniels, says that the District of Columbia was one of the early jurisdictions to recognise that captive insurance would be a significant alternative for experienced insurance professionals to maximise efficiencies and options that were not readily available in the traditional insurance marketplace.
“To accomplish this goal the department of insurance, securities and banking brought together a group of insurance, legal, accounting and other professionals to assure appropriate and collaborative captive regulation and to develop a cutting edge captive law.”
“After much effort and discussion the district enacted what is generally recognised as one of, if not the best, captive laws in the US. A very creative and flexible law was drafted to permit insurance professionals to create both large and small captives. For example, required capitalisation was designed to permit relatively small simple captives as well as very large and complex captives with a number of structural options that were suitable for both.”
Most notably, the law’s best practices provision, which was modelled on state banking laws, permits a District of Columbia captive to “do anything a captive can do in any other captive domicile in the world”, says Perschetz. “It provided that the commissioner of insurance must approve the request for ‘Best Practices’ treatment within 30 days unless it is determined that the proposed provision would be adverse to policyholders. Consequently, the district by virtue of its cutting edge cell captive law and collaborative regulation provides significant benefits to those looking for a forward focused and flexible captive domicile.”
Cellular innovation
The District of Columbia included protected cell captives in its first captive legislation in 2000, with subsequent amendments to the law including the ability to create incorporated cells. The current incorporated cell law was modelled on the more flexible and comprehensive Guernsey and Jersey laws and was enacted in 2006. “It has become the universally recognised best cell law in the US and has been utilised by many cell captive owners and users,” states Perschetz.
The district’s new law included the first incorporated cell provision in the US: a favourable US branch captive provision that gave significant flexibility in the types of investments and credit for reinsurance.
“Both types of captives provide a wide array of options and are available for cell captive users,” asserts Perschetz.
The protected cell captive, a contractual captive, is formed around a core that serves as the central business entity and has captive cells that are contractually related to the core and each other.
“The district’s law specifically provides that these cells are treated ‘as if they are legal entities’. This language is an important provision as the integrity of captive cells has never been successfully challenged. The law also permits cells to contract among each other as if they are legal entities and is an important provision not currently available in other captive domiciles.”
The incorporated cell captive, as in a protected cell, contains a central core. Each participating cell is also incorporated and is, by law, a separately recognised legal entity.
“The incorporated cell is said to have ‘walls’ separating the cells and the core which are both ‘higher’ and ‘thicker’ than those of protected cell captives. This concept is supported by the well-established legal doctrine of ‘piercing the corporate veil’, which provides a significant legal basis for the integrity of the cell. Although the incorporated cell is clearly protected by case law, the protected cell does not have this benefit. However, carefully drafted legal documents used by a protected cell captive will likely also protect the integrity of a well managed protected cell company.”
One key difference between the types of cell captives in the District of Columbia, asserts Perschetz, is that protected cell captives aggregate premium from all cells for the purposes of the domicile’s minimum and maximum premium tax requirements as one entity, so they could possibly reduce premium tax expenses. In an incorporated cell captive, the core and the incorporated cells must file individual premium tax returns and are each subject to minimum and maximum premium tax limits.
Protected and incorporated cell captives are distinctly different, but do contain similarities. Cell captives of both types may use another entity’s capital for core funding, although some of the expense would typically be passed onto each cell. Cells also facilitate formation for those entities with lower premium volume. The District of Columbia’s law also permits a cell to move to another cell, to leave the cell captive and become a standalone, and a small captive to become a cell of a cell.
“The advantages of either form of cell captive include being less expensive to organise, more flexible capitalisation, more efficient operation and less costly management expenses,” concludes Perschetz. “A well managed cell captive can become a turnkey operation for individual cell owners that want to create and own a captive cell without significant front end expense and can typically be formed more rapidly than a standalone captive.”
