When you are reviewing your financial requirements, particularly in the area of alternative risk financing structures, consider the benefits that are provided to you by a British Columbia captive insurance company. British Columbia's location is highly accessible and has an international business orientation and an infrastructure to support your unique needs.

Dan Miller
Minister

Province of British Columbia
Minister of Employment and Investment
Parliament Buildings
Victoria, British Columbia
V8V IX4
Telephone: (604) 356-7020

• Underwriting profits are retained and there is the ability to earn investment income on claims reserves and unearned premium reserves
• Companies have the option to purchase selected services from outside suppliers while performing other services in-house

• Safeguarding of corporate assets is a key consideration
• Separate financial statements focus attention on risk management
considerations

• Premiums paid by insureds are tax deductible
• B.C. captives can establish tax deductible loss reserves, which is not possible if losses are retained corporately through self-insurance

• Captive insurance companies have direct access to reinsurance markets, allowing flexibility in developing and designing coverage
• Reinsurance is the equivalent of a wholesale market, therefore offering potential cost savings
• Reinsurers take a long-term view and provide greater price stability
• Cash flow benefits can be achieved as captives often receive a commission for placements, and premium payments are often due in installments rather than requiring 100% prepayment

• Centrally retain risk at a level that a group can afford, while allowing operating units to retain risk levels which they can individually afford

Flexibility

• Create a risk funding program that is tailored to the specific needs of an organization

• Accept risk that may otherwise be uninsurable (for example, strike insurance, environmental liability insurance)

• B.C. captives can be used to meet special requirements, fill gaps in claims-made policies, offer additional limits of liability and supplement any restricted forms obtained from the conventional insurance market

• As any cost savings flow directly back through the captive to the parent organization, there is incentive for:
  - obtaining better risk management information
  - distributing loss costs equitably among profit centres
  - designing more effective loss control programs
  - implementing loss control programs throughout all divisions or subsidiaries
• For many companies, particularly those with geographically dispersed subsidiaries, a captive offers an effective means of ensuring centralized control of a diverse risk management program

• Where capacity limitations are encountered in the conventional insurance markets, a captive can provide access to additional capacity, often at lower prices, either from the international reinsurance market or by retaining the risk itself

• As the captive matures and its surplus grows, it becomes capable of retaining greater portions of an organization's risks, thereby reducing dependence on commercial insurance while improving the captive's position with reinsurance markets

• The insurance industry is subject to considerable changes in pricing and availability of coverage. A captive can create a stable base from which the insured can be confident of obtaining price stable coverage, irrespective of the commercial market offerings

• Control over claims administration allows for consistency in the philosophy and methodology of handling claims

Is the parent organization willing to make the necessary commitments?

Forming a captive requires commitments of time, and initial funding by the parent. The degree of these commitments depends on the size of the organization and the extent of the captive's role in providing alternative risk financing means for the organization.

Are the goals of the captive and the organization focused?

It is important that the goals of the captive be well defined and appropriately managed in its infancy if it is to be successful over the long term.

Does the concept of a captive mesh with the overall corporate strategy?

The ideal organization to form a captive is one that is willing to forego transferring some risks to the conventional markets, but that wants to operate conservatively by funding for them.

Is there a strong leader?

All successful captives, be they a single parent or group program, must have a strong leader to see the program through its many phases. The more influential the leader, and the more fervently he or she believes in the merits of a captive, the greater are its chances of success.

In 1987, British Columbia became the first Canadian province to enact legislation for the creation of domestic captive insurance companies. The Insurance (Captive Company) Act is a relatively brief and extremely flexible statute incorporating, by reference, sections from other British Columbia statutes, including the Company Act, the lnsurance Act and the Financial Institutions Act.

Three types of captives are permitted:

The Pure Captive
The Pure Captive, or the single parent captive, may insure the risks of its parent, its parent's affiliated corporations (majority owned) and their officers, directors, employees, agents or independent contractors.

The Association Captive
The Association Captive may insure the risks of the members of an association (that has been in existence for over one year), their affiliates, and their officers, directors, members, agents or independent contractors.

The Sophisticated Insured Captive
The Sophisticated Insured Captive is intended to cover a group of insureds who may be unrelated except for their participation in the captive. Where groups of companies do not qualify for a Pure Captive, not being majority owned, the Sophisticated Insured Captive can be utilized. Each member of the group must spend a minimum of Cdn$500,000 in annual premiums and must have "expertise" in insurance matters. The Sophisticated Insured Captive may insure the risks of the group, their affiliated corporations, and their officers, directors, employees, agents or independent contractors.

B.C. captives may write any line of insurance business within the meaning of the Insurance Act except:

1. Surety insurance, other than reinsurance of surety insurance,
2. Life, sickness, disability or personal accident insurance where the beneficiary under the policy is identified by any method other than being within a group,
3. Insurance of motor vehicles, other than fleet insurance by a corporation.

The intent of the legislation is that B.C. captives only insure the risks of their owners and not the risks of the general public.

Regulatory Environment
B.C. captives enjoy an accommodating regulatory climate, with minimal government intervention. Licensing is a simple, speedy process with convenient annual renewals. The regulators review standard indicators of solvency and performance; however, there are no statutory solvency or performance measures that must be met. This approach evaluates each captive on its merits and allows maximum flexibility.

Captive insurance companies formed under the Insurance (Captive Company) Act are given considerable latitude in the scope of allowable investments. There are no set limits, and the regulators examine the portfolio of each captive for prudence in its own unique circumstances.

The minimum level of capitalization for B.C. captives is Cdn$200,000. The amount of capital required is dependent on the insurance program being written, and larger programs will require a larger amount of capital. In addition, the minimum level of reserves to be maintained after initial registration is Cdn$100,000.

The application process is straightforward. A business plan must be submitted, along with an application package which can be obtained by writing to:

Financial Institutions Commission
Suite 1900, 1050 West Pender Street
Vancouver, B.C. V6E 3S7

In order to reduce uncertainty surrounding regulatory issues faced in these situations, most captive programs that extend outside of British Columbia are 'fronted'. This means that a licensed insurance company is used to issue the policy to the insured, and a reinsurance agreement is entered into between the licensed insurance company and the captive. The fronting company can, and in most cases does, provide other services to the insured, such as loss adjusting and reporting, policy issuance, and assistance in premium rating. The fronting company can also participate in the program as an excess insurer, providing insurance above the limits that the captive wishes to retain for its own account.

For U.S. exposures, a B.C. captive would be considered a non-admitted carrier and would be in the same position as any other captive in the eyes of the various state regulators. Therefore, to avoid regulatory problems, it is advisable to front U.S. exposures. There is currently a flurry of activity with respect to U.S. regulations in this area and the outcome is not certain.

Fronting services do come at a cost, which typically varies from 5% to 12% of the gross premium. It may be possible for the captive to write direct policies covering risks domiciled in other provinces; however, this is subject to some degree of uncertainty. The operating protocol of the captive must be designed and followed with the utmost care and attention. If a program is written direct, the other services typically provided by a fronting company must still be obtained, and the applicable costs taken into account.

If there are significant exposures in the Province of British Columbia, there is a distinct advantage to a B.C. captive as that portion of the policy that applies to British Columbia risks can be written direct by the captive, and fronting fees would not apply to the premium attributable to those risks. In practice, most captive programs are fronted, irrespective of where the captive is domiciled.

Accountants

All of Canada's major accounting firms are represented in Vancouver, along with many smaller independent firms. A number of these firms have been involved in preparation of the financial projections required to license a B.C. captive, as well as in the completion of the annual Auditors' Statement to the Superintendent of Financial Institutions.

Actuaries

Actuarial services are readily available.

Banks

All of the major Canadian chartered banks and many foreign banks have significant operations in Vancouver

Consultants

In Vancouver there are a number of independent insurance consulting firms with specialist expertise in captive feasibility studies and formation. In addition, a number of the major insurance brokers, all of whom are represented in British Columbia, have specialty divisions or subsidiaries involved in risk management and captive insurance company consulting.

Investment consultants

Vancouver is home to a number of investment managers and brokerage firms, and as well there are local offices of national investment firms owned or controlled by the major Canadian chartered banks. There is plentiful expertise to take care of the investment and financial planning needs of B.C. captives.

Lawyers

There are approximately 5,000 lawyers practicing in the Vancouver area, a number of whom have specific expertise in captive insurance companies. Certain lawyers and law firms have had a good deal of involvement in the incorporation and licensing of B.C. captive insurers, while others have specialized in claims handling and litigation for captive insurers and self-insured programs.

Managers

Major insurance brokers and a number of independent firms have captive management expertise and experience in their Vancouver offices. These manager's have been involved in managing captive insurers under the Insurance (Captive Company) Act since its inception, and have the expertise and knowledge to ensure first class captive management.

Reinsurers

Vancouver is home to a small but growing reinsurance market with expertise being developed in the specific area of captive reinsurance.

The cost of living in British Columbia is roughly the same as that in Washington, D.C. This puts British Columbia in the same cost of living range as major U.S. domiciles such as Vermont, Hawaii, and Colorado. The cost of living is, however, approximately 20 to 30% less than in offshore domiciles such as Barbados, Bermuda and the Cayman Islands.

The cost of living effect is that operational costs for a B.C. captive, including staffing and the provision of technical services such as legal, accounting and claims management, generally do not exceed those of U.S. domiciles, and these costs can be expected to be significantly less than for offshore domiciles. In fact, costs may be considerably less than U.S. domiciles since captives in British Columbia are normally established in Vancouver, which is a large cosmopolitan city with a well-established professional infrastructure.

One potentially distinct difference between British Columbia and U.S. domiciles, especially, is that premium tax is not charged on risks located outside Canada. For example, a U.S. owner establishing a B.C. captive would not pay premium tax to the British Columbia government for insurance of its U.S. operations. Premium taxes for U.S. captive domiciles are generally in the range of 1/2% to 3/4% of premium written regardless of where the risk is located. The absence of premium tax in these situations could be a major consideration in selecting British Columbia as a domicile. A U.S. owner, for example, could annually save in excess of $25,000 in premium tax on a premium level of $5 million per annum.

Federal Excise Tax

Generally, a 10% excise tax is imposed by the Canadian government on premiums for insurance placed outside of Canada. An exemption is granted for insurance coverage not available in Canada, and for contracts of reinsurance. However, since a B.C. captive is located in Canada, no excise tax applies. Premiums placed directly with an offshore captive for insurance generally available in Canada attracts this tax, unless the program is fronted.
For U.S. exposures, the U.S. government imposes an excise tax of either 4% on direct policies (not fronted) or 1% on reinsurance premiums (fronted programs).

Premium Taxes

Premium taxes are payable in every province of Canada on both licensed and unlicensed insurance. The rate of tax varies with the class of insurance. Licensed insurance generally attracts a rate of approximately 3% of the gross premium written, while the unlicensed rate varies by province.
British Columbia's premium tax rate for unlicensed insurance is currently 7%, while some of the other provinces impose much higher rates (Alberta - 50%), which are intended to be punitive and to force the use of licensed insurance. Since the tax applicable to licensed insurers is less than that applicable to unlicensed insurers, there is further incentive to have a captive program fronted if it involves risks outside British Columbia. For companies insuring significant British Columbia risks there is a distinct advantage to the use of a B.C. captive, as that portion of the policy can be written direct, thereby avoiding fronting fees.

Canadian premium taxes do not apply to U.S. exposures. Premium taxes are only payable on policies covering persons resident and property situated within a particular province. Premium taxes on U.S. risks would be payable to the state where the insured corporation is resident or where the property is situated.

Unlike many U.S. domiciles, British Columbia does not impose any additional premium taxes related to B.C. captives. In comparison, premium taxes for U.S. captive domiciles are generally in the range of 1/2% to 3/4% of premium written regardless of where the risk is located.

Federal Withholding Taxes

Certain payments from residents of Canada to non-residents, including investment income, attract federal withholding taxes. Unless reduced by treaty, the general rate is 25%. For off shore captives that may be required by the fronting company to provide trust funds as security for their obligations to the fronting company, this may present a problem. It is generally accepted that withholding taxes do not apply to insurance and reinsurance premiums.
Since a B.C. captive is a resident of Canada, withholding taxes are not an issue when dealing with a Canadian fronting company.

Income Taxes

Canada's income tax system is based on residency. Residents are taxed on their worldwide income. Non-residents are taxed on income attributed to carrying on a business in Canada.

Residency

Canadian income tax is payable by corporations considered to be either resident in Canada or carrying on business in Canada. Companies incorporated in Canada after 1965 are deemed to be resident for tax purposes, and a B.C. captive is, therefore, a taxable Canadian corporation. One of the main advantages of an offshore captive is that these jurisdictions normally provide an exemption from income taxes. While offshore captives do not pay income tax to their local governments, they must diligently watch how their affairs are handled to ensure that the Canadian tax authorities do not catch the income of the captive in the Canadian tax net.

Residency is not defined in the Income Tax Act. It is determined on the facts of each case and based on previous court rulings. One of the tests to establish residency is the "mind and management" test. If management control is exercised over the business decisions of the company from Canada, then the company may be deemed to be a resident of Canada for tax purposes. This could potentially undermine one of the reasons for establishing a captive offshore.

FAPI

Foreign Accrual Property Income ("FAPI") rules, which are applicable to offshore captives only, attribute certain types of income to the Canadian shareholders directly, and the shareholders must include this income in their own taxable income calculations on a current basis. The intent of the rules is to prevent Canadian taxpayers from avoiding tax on inactive income, including premium and investment income earned by an offshore captive attributable to the insuring or reinsuring of Canadian risks. However, the FAPI rules were not very effective in taxing the income being generated by offshore captives. Accordingly, the Canadian Federal Budget of February 22, 1994 changed the rules significantly so that most income earned by offshore captives is now caught in the FAPI net.

These FAPI rules are extremely complex and subject to a variety of exceptions. It is generally accepted that a company should employ a tax expert specifically skilled in this area to review the application of these rules and, if necessary, to complete the related documentation and filings if FAPI does apply.

Under the new FAPI rules, which generally have effect for taxation years commencing after 1994, the insurance or reinsurance of Canadian risks will be caught in the FAPI net with limited exceptions. These exceptions will, in most cases, be very difficult to meet. The insurance or reinsurance of non-Canadian related company risks will also be caught in the FAPI net unless the captive employs six or more full-time people and its business is conducted principally with arms-length persons. Since Canadian risks in most cases will be caught in the FAPI net the captive domicile in British Columbia is probably more appropriate when all factors are considered.

The vast majority of captive business is related company business. In British Columbia, the rules specifically preclude captives from writing third party business. For any companies contemplating programs involving third party business, this would have to be done offshore.

It is vitally important that the captive be well planned, for it involves the creation of a facility that must meet risk financing needs both today and in the future. In British Columbia, the goal is to provide captive insurance companies with all of the services and support necessary to make the facility an integral component of a successful risk management program.

If you have decided that the formation of a captive facility might be right for your organization:

1. Discuss the subject with your current insurance broker and meet those responsible for the management of the captives of their other clients. If the broker does not have a captive management capability, talk with either another broker who has or an independent consultant who specializes in advising clients about the benefits of establishing a captive.

2. Meet with the British Columbia regulatory authorities.

3. Have a captive manager or independent consultant perform a feasibility study. The study can range from a brief analysis to a full length study. Included in the study should be an actuarially determined loss projection, a domicile comparison and a financial analysis. As part of the study, identify the legal, tax and accounting issues that need to be addressed by appropriate advisers.

4. Analyze the study and resolve any outstanding issues.

5. Prepare a business plan for the captive.

6. Incorporate a British Columbia company and prepare the necessary captive application forms.

7. Market any insurance or reinsurance for the captive.