Tumbling Insurance Industry- Jurisdiction & Domicile Issues for Specialty Insurers

In the United States, the insurance industry is primarily regulated by the regulations of the various states in which the insurer operates. Each state has its own rules, regulations and requirements that need to be complied with in order for the specialty insurers to operate and write policies in such state. The insurance laws of each state of the United States expressly prohibits the sale of insurance policies within their jurisdictions by insurers that are not admitted to do business within such state. The regulatory framework varies from state to state, but generally relates to the standards of solvency that must be met and maintained, including risk-based capital standards, licensing approvals and related matters, restrictions on insurance policy terminations, the nature of and limitations on the amount of investments made with the insurer’s capital and periodic examinations of the financial condition and market conduct of insurance companies. Regulations pertaining to specialty insurance companies may be less onerous than those required of insurance companies engaged in property, casualty, life and health insurance. None the less, this is not to say that specialty insurance companies are not subject to relatively rigid and potentially burdensome regulatory frameworks.

The selection of a domicile is a very fact specific determination based upon the individual circumstances and facts applicable to the particular insurer. A review of the jurisdiction of domicile for the various insurance companies operating in the United States demonstrates that no single state offers an overwhelming distinctive advantage to domicile in a particular state over another (i.e. there is no “Delaware” for insurers). Various factors that seem to come into play include: (i) the physical location of its business, (ii) location of policyholders, (iii) historical remnants and factors that may no longer apply (e.g. an insurer that began operating in only one state and later expanded its business elsewhere), and (iv) the solvency and minimal capital requirements of a particular state (which vary from state to state depending upon the kind of insurance being offered by the insurer). Further, if the proposed enterprise decides to initiate operation by acquiring a shell, the choice of domicile is likely already made and not worth the burden of changing.

An alternative to domiciling the enterprise in the United States would be to select an offshore jurisdiction like Bermuda, Cayman Islands, or the British Virgin Islands. Each of the foregoing are attractive jurisdictions to insurance companies due to favorable regulatory frameworks and advantageous tax policies. In recent years, Bermuda in particular has become a very attractive offshore jurisdiction for insurers. Among other advantages, Bermuda offers an established infrastructure, political stability, trained and educated workers, evolved regulation, and a convenient geographic location. In addition, Bermuda also offers the following specific advantages:

1. Taxation

The governments of Bermuda and the U.S. signed a convention in 1986 relating to the taxation of insurance enterprises, thereby allowing subsidiaries of U.S. Companies to be set up in Bermuda and be taxed as per Bermuda laws.

Bermuda’s taxation system is “consumption based” meaning there are no taxes on profits, dividends or income for companies or individuals, nor are there any capital gains or inheritance taxes. Companies pay a payroll tax rather than being taxed on profit, income or dividends. Companies tend to find a tax advantage by setting up a Parent company in the United States with operating subsidiaries in Bermuda and the United States. Under this structure, the risks and premiums can be shared between the United States subsidiary and the Bermudan subsidiary, allowing the insurer to take part in some of the offshore tax advantages while also maintaining the regulatory advantages of having a domestic domiciled operating company.

2. Speed and Cost

The regulatory framework in Bermuda is very streamlined and efficient and permits enterprises to form and domicile insurers in Bermuda very quickly. The efficiency in Bermuda offers a considerable edge over other jurisdictions. A company can secure capital, obtain a license and be up and running in as little as six weeks in Bermuda. The same process may take over a year in the United States. Also, compared to other jurisdictions, the set-up and formation cost is significantly less expensive. It should be noted however, a Bermudian domiciled insurer would still need to obtain regulatory approval as a foreign insurer in each of the various fifty states in order to operate and write policies in such states.

3. Business in offshore jurisdictions

By establishing an operating company in Bermuda, an insurer can offer and write policies to non United States policyholders without having to comply with potentially burdensome regulatory requirements applicable to United States domiciled insurers. In addition, as a non United States domiciled insurer, it may be possible in certain instances to conduct a totally offshore transaction with a United States policyholder which would not be subject to the regulatory frameworks of the fifty states. Whether any individual policy underwriting could be considered “offshore” is a very fact specific determination but usually involves ensuring that all activities (including solicitation and negotiation) be conducted offshore.

On a precautionary note, the tax benefits afforded by domiciling in Bermuda are only advantageous when the enterprise is making a profit. If the company is incurring losses, as has been the case for many entities affected by the current financial crises, there is a disadvantage because Bermuda, unlike the United States, does not permit the offsetting of losses against future profit. Moreover, it should be noted that in order to take advantage of any tax benefits, the company must meet a 'mind and management' test that includes holding board meetings in Bermuda and other requirements, which may be onerous for some insurers.