U.S. owners of captive insurers covering international risks must examine their captives closely to ensure they don’t run afoul of a global effort to stop tax avoidance schemes.

But the preparations that captive owners engaged in ahead of Solvency II, the European Union’s risk-based capital rules for insurers and reinsurers that came into force in January 2016, should help smooth the compliance pathway for this initiative, according to experts.

The Base Erosion and Profit Shifting, or BEPS, initiative jointly led by the Organization for Economic Co-operation and Development and the G-20 refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or no-tax locations, with an action plan published in 2013 that identified 15 specific actions to give governments tools to prevent corporations from paying little or no taxes. Fifty-four countries, including Australia and the United Kingdom, have implemented the framework, while seven countries have draft bills to do so and 15 have announced their intentions to implement the framework, according to a Sept. 8 summary by KPMG L.L.P.

“We see it impacting Europe more than the U.S.,” said Peter Mullen, CEO of Aon Captive and Insurance Management in Pembroke, Bermuda. “In the U.S., you have quite a few captives where the risk written in the captive is in the U.S., so the premiums paid into the captive stay there so there’s no shifting. It’s been more of a concern in Europe (because) the location of the risk and the domicile are generally different and, proportionately, there’s more multinational business in European captives than in U.S. captives so there’s more shifting of premium from one country to another.”

The initiative isn’t specifically focused on captives, but the action plan cited captives as an area of concern, meaning captives will be particularly susceptible to BEPS scrutiny as regulators work to ensure they are not used as vehicles to facilitate profit-sharing and general tax avoidance, according to Willis Towers Watson P.L.C.

The implications of BEPS scrutiny range from double taxation or inadmissibility of tax deductions from premiums, increased time and costs from audit and negotiations with tax auditors, and reputational risk — risks that could threaten the viability of the captives.

“Originally as BEPS was being articulated, there was a notion in the U.S. that this was yet another European issue like Solvency II — it isn’t going to really affect us,” said Sean Rider, Willis Towers Watson’s executive vice president and managing director based in New York. “No, it’s not going to affect U.S. very much, but it is going to affect every U.S. captive owner who uses a captive as part of a global insurance program. It’s the international nature of the insurance programs across tax regimes that triggers a need for awareness around BEPS. I think the risk management and captive community in the U.S., who can be very North America-centric, is getting a greater degree of sophistication and awareness of the need to manage the compliance.”

BEPS compliance will not be a concern for the vast majority of captives that do not have an international footprint, but “for the larger accounts who use their captives for direct issue programs, who use global fronting arrangements … BEPS compliance is a must,” Mr. Rider said.

“I think it’s been slightly underestimated in the U.S.,” Mr. Mullen said.

U.S. captive owners should examine whether the amount of premium being charged to particular countries aligns with the risks covered in the captive, said Michael Serricchio, managing director with Marsh Captive Solutions based in Norwalk, Connecticut. For example, a manufacturer that uses the captive to cover risks such as product liability and workers comp should ensure “there are no coverages that don’t make sense and no egregious premiums coming out of any one country.”

“You want to make sure the captive looks and feels appropriate from a business perspective,” he said.

But Solvency II was helpful for captives needing to demonstrate BEPS compliance, Mr. Serricchio said.

Solvency II’s three pillars focused on capital adequacy, governance and risk management of insurers and effective supervision, and disclosure and transparency requirements.

“That’s a lot of what BEPS is trying to capture in its net,” he said. “It’s a good thing that Solvency II came first.”

Given the preparatory work done for Solvency II, experts believe there is no major cause for alarm about the BEPS initiative, although they are urging captive owners who may be affected to pay attention and soon examine their captives for any potential areas of noncompliance.

“There’s a need for some concern,” Mr. Serricchio said. “There’s a need for some review. But I don’t think it’s a big, scary thing that is going to have captives start closing down. I think that it’s just another form of prudent regulation that’s going to end up helping captives versus hurting them.”