Owners should consider all factors before switching captive domiciles

BURLINGTON, Vt.—Captive owners must carefully weigh the pros and cons before pulling up a captive's roots and planting them in another domicile.

Initial decisions in forming a captive often center around location—particularly whether the captive will be onshore or offshore—and each offers advantages, said Paul Smith, manager at the insurance and actuarial advisory services division of Ernst & Young L.L.P. in Chicago.

Mr. Smith made his comments during a panel discussion at the annual Vermont Captive Insurance Assn. meeting in Burlington, Vt., earlier this month.

To contain costs, some organizations avoid setting up captives offshore or in a domicile in a distant U.S. location. On the other hand, capitalization and surplus requirements are typically lower offshore, and easy access to reinsurers is a big reason why many select Bermuda as a domicile, Mr. Smith noted.

Captive owners may choose to stay put for a variety of reasons, he said. Those reasons include so-called "frictional" costs since it can be expensive to change domiciles; regulatory hurdles since some domiciles are more accommodating about moving captives than others; and relationship management since moving a captive may require breaking longstanding arrangements with managers, local lawyers and service providers.

Among captive owners currently considering a domicile shift—often termed "redomestication"—the most common reason for moving is perception issues linked to offshore entities, Mr. Smith said.

He cited an example of a philanthropic health care organization's Cayman Islands-based captive that, even though it did not experience problems in the Caymans, decided to bring its captive onshore over reputational concerns that it was using funds irresponsibly.

Personnel changes in a domicile's regulatory structure or a captive's parent company also may result in redomestication, he said.

Furthermore, Mr. Smith noted, a growing reason some captives have moved to onshore is access to the federal terrorism backstop, which requires captives to be domiciled in the United States to tap its funds.

But other issues also cause captives to move, said Frank Lagerstedt, executive director in Morgan Stanley's risk and insurance management department in New York and president of Customer Asset Protection Co.

CAPCO is a Vermont-based group captive that provides excess coverage above what is provided by the Securities Investor Protection Corp. to broker/dealers for institutional and individual clients' securities accounts.

CAPCO was domiciled in New York in late 2003 but moved to Vermont less than a year later after the confidentiality of the captive members' operations came into question. A Freedom of Information Act request to New York about the captive's dealings was rejected initially, but state officials said in the future they might release certain information that CAPCO sought to keep confidential, Mr. Lagerstedt said.

He subsequently approached Vermont regulators, who were willing to ensure that confidentiality, and so CAPCO moved.

"You want to have a good relationship with your regulators," Mr. Lagerstedt stressed. In most domiciles, a captive must be legally released by the current domicile to move to a new one, so captives need regulators on their side to expedite the moving process, he said.

CAPCO's move was relatively painless because the captive had frequent, up-front communication with regulators in both states and it was able to retain the same service providers when it moved to Vermont, Mr. Lagerstedt said.

Panelists agreed when one audience participant—a 20-year veteran of the Bermuda captive industry who recently moved a captive to a U.S. state—noted that captive moves can be far rockier when service provider changes are involved.

Additionally, moving a so-called "alien," or offshore captive, onshore is generally a more complex process than moving within the United States, said P. Bruce Wright, partner at the New York-based law firm of LeBouef, Lamb, Greene & MacRae L.L.P.

Tax implications could be thorny in an offshore-to-onshore move, as earnings abroad may be taxed if the captive was not already compliant with U.S. tax laws, Mr. Wright said.