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Captive owners coping with Brexit, US tax reform

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SOUTHAMPTON, Bermuda — Brexit is forcing captive owners to make changes as companies flee the United Kingdom, but owners see U.S. tax reform as a long-term positive for their captives.

Santiago Garcia, global insurance manager, specialty risk unit, for Caterpillar Financial Insurance Services based in Nashville, Tennessee, said most of the captive insurer’s non-U.S. liability exposures have been placed in London.

“We will see changes going forward because our fronting partner is leaving the U.K., but we’re still going to need to have a policy and a program in place in the country,” he said at the 2018 Bermuda Captive Conference in Southampton, Bermuda, on Tuesday.

General Motors Co. completed the sale of its European division Opel to the PSA Group in July, so the company’s exposure to Brexit will be “significantly reduced,” said Alan Gier, Detroit-based global director, risk and insurance for the auto manufacturer.

“We still have some exposures, very little legacy exposures, but we think can meet our requirements through our fronting arrangement with a carrier that will move to the continent,” he said.

Scott Reynolds, Cornelius, North Carolina-based president and chief executive officer of Member Insurance, said he sees positive implications for his company’s primarily domestic investment portfolio.

“Any uncertainty that Brexit might create overseas actually creates more attraction for the securities that we hold,” he said.

In December, President Donald Trump signed the Tax Cuts and Jobs Act, which replaced the graduated corporate income tax structure and its previous top rate of 35% with a 21% rate, among other things.

“For us, the tax reform obviously is a good thing long term,” Mr. Reynolds said, adding that his captive is registered under Section 953(d), which allows a controlled foreign corporation engaged in the insurance business to affirmatively elect to be treated as a U.S. corporation for U.S. tax purposes.

“Long term, obviously it’s a benefit for us to go from 35% to 21%,” he said, adding that the company took a one-time write down due to a net operating loss. “But that’s simply a one-time thing. There’s really no long-term downside to us.”

General Motors also took a one-time write-down for its captive in December, Mr. Gier said.

“Longer term, we see that as a benefit, especially for the parent company,” he said. “We’re happy with the outcome.”

Tax reform changed the cash flow and financial benefit projections for Caterpillar’s captive “drastically,” leading to a “significant drop” in its financial benefits, Mr. Garcia said.

“However, there is still a significant amount of benefits behind it in terms of control, in terms of understanding the data, gathering information all over the world that we do not have, basically centralizing that information and having better capacity to manage those products,” he said.

Manufacturer Linamar Corp. just received permission to form its Bermuda-domiciled captive, but does not anticipate an impact from U.S. tax reform, said Dageria Morgan, treasury manager for the company based in Guelph, Ontario.

“We were very strategic when we were forming our captive to not focus on the captive being a tax play for us,” she said.

But captive owners said they are also watching for potential impacts related to the European Union’s wide-ranging data security rules, the General Data Protection Regulation, which came into force in May, and the uncertainty surrounding the future of the North American Free Trade Agreement and a potential trade war with Canada, Mexico and other countries.

“The uncertainties around NAFTA are certainly a great concern for us,” Ms. Morgan said. “The competitiveness of the North American market is at risk with NAFTA being out of the way.”

General Motors uses 90% domestic steel, so the tariffs would not affect the company dramatically, but they could lead to higher prices, Mr. Gier said.

“NAFTA obviously would have a huge impact on the company, given the manufacturing footprint in Mexico and Canada,” he said. “But our feeling is that this will get sorted out in the right way. The agreement needed to be updated because it hasn’t been touched in so many years.”

GDPR is the “current big item” for Microsoft Corp., said Stephanie Lampi, senior risk manager, business risk management, for the Redmond, Washington-based information technology giant.

“As a company that’s involved in a lot of data, it’s really important for us to implement,” she said. “At Microsoft, we believe privacy is a fundamental human right. In addition to complying with GDPR, we’ve actually taken the heart and the intention of the program and expanded it and applied it to all of our customers, supporting that privacy not just for Europeans, but for all of us that use Microsoft services.”

But the captive owners had a more mixed approach to handling cyber risk in their captives.

There continues to be “a lot of debate” in the industry about the effectiveness of cyber risk insurance policies, Mr. Gier said.

“We have no intention at this point to run it through the captive,” he said. “It’s a type of volatile risk, and I don’t know if I should believe Evan Greenberg or Warren Buffett.”

Berkshire Hathaway Inc. will not take on significant cyber risk because of the lack of industry understanding of the risk, Mr. Buffett reportedly said at the insurer’s annual shareholders meeting in May — a stance Mr. Greenberg reportedly rejected last week at a conference in New York.

“Do we have an exposure?” Mr. Gier said. “Sure. People are concerned about autonomous vehicles being hacked … but we have a very dedicated team working that.”

But Microsoft did use its captive to incubate a cyber program, Ms. Lampi said.

“We actually put a policy in the captive, and we’re able to build up experience (and) data history that we’re now able to take to the markets and get the reinsurance that we want on it,” she said.