If you read a report from the:
Bureau of the Committee on Fiscal Affairs
Centre for Tax Policy and Administration
Organization for Economic Cooperation and Development
2, rue André Pascal 75775 Paris Cedex 16 France
… you probably would not be surprised to find a report suggesting businesses do not pay enough in taxes. And, you might possibly expect to find references to “fairness” and “responsibility” regarding businesses and their efforts to reduce their tax burdens on behalf of their shareholders.
In light of last week’s Captivating Thinking article about Apple avoiding taxes to the tune of tens of billions of dollars through multi-national subsidiaries (and many other large corporations utilizing similar practices), one would think the Organization for Economic Cooperation and Development would have plenty upon which to focus their efforts. However, their February 2013 report on “Base Erosion and Profit Shifting” makes a few small references to captive insurance companies as a vehicle used by large corporations for “profit shifting.” Their report demonstrates ignorance (at best) and blatant over-reach (at worst) in their criticism of the captive insurance industry.
Fortunately the Captive Insurance Companies Association (CICA) and the European Captive Insurers and Reinsurers Owners Association (ECIROA) have taken the OECD to task in a well written letter that lays out facts about the industry and offers to meet and provide a thorough explanation of the utilization of captives in risk management to the OECD.
The Captive Insurance Companies Association (CICA) and the European Captive Insurers and Reinsurers Owners Association (ECIROA) are two associations organized on a multi-national, jurisdictionally neutral basis to speak for captive insurance companies and those who interact with captive insurance companies. The letter from CICA and ECIROA clearly demonstrates that the OECD really does not understand complex risk management, the commercial insurance industry and the critical role captives play in complex risk management.
The letter notes that, “Captive insurance companies (CICs) provide insurance coverages that are often not available in the commercial insurance market,” and CICs “create an environment of competition within insurance markets that benefits both the purchasers of insurance and the governments that rely on the success of the companies that utilize captive insurance arrangements.” The point is simple. CICs are often tied to strong companies – companies that provide employment and support local economies.
The CICA letter is thoroughly educational and also notes the following:
- Captives are an integral part of the “enterprise risk management” of Multinational Enterprises (MNE). Captives are the state-of-the-art model providing a professional “total cost of risk” picture for all corporations engaged in production, distribution and provision of services within numerous different countries.
- CICs develop a higher level of risk awareness by the insured, more intensive/visible and reactive local risk management, lower vulnerability and ultimately lower cost of production and services for the end consumers.
- CICs provide the insured with a higher level of transparency in areas such as commissions, fees, and administration costs for claims handling and processing.
- Captives are the only tool available to MNEs to manage otherwise uninsured risk exposures in a formalized and regulated way. Captives insure more efficiently those risks which the professional insurance market does not want to accept because they involve high costs of administration and claims handling, i.e. the area of high frequency/low severity losses.
- Captives allow MNEs to reinsure risk directly to the reinsurance market (which is not possible without captive involvement) and thereby can access the higher levels of capacity they need to protect their risks.
- Captives allow their owners/parent company to insure risks which are, to a certain extent, uninsurable in the traditional insurance market. This has created an opportunity for the development of new insurance products once the “professional” insurers realize that the insurability (and quantification) of a risk they formerly declined to cover is calculable.
- Captives in the United States are widely utilized by small and medium sized businesses and not-for-profit organizations to address insurance placement challenges not addressed by the traditional insurance market. For example, a significant majority of non-profit hospitals in the U.S. utilize captives to cover their medical malpractice insurance requirements rather than relying on the volatile commercial insurance market that has a history of wild pricing and availability swings. Obviously, since the captives for these not-for-profit organizations are not subject to taxes,
- The most important point is that captive insurance companies are just that – insurance companies. Like all insurance companies, they are highly regulated by the financial authorities where they are registered. Captive insurance companies are a risk financing tool that is essential for stable business operations, not a tax avoidance business.
It is certainly encouraging to know that organizations like CICA and ECIROA are actively watching out for the best interests of the industry and the thousands of companies that benefit from risk management through CICs.
After reviewing the letter to the OECD, one other point comes to mind. All insurance purchases (whether through a third party commercial carrier or through a captive) are a form of “profit shifting.” If a company were to choose to not insure its risks (and was fortunate enough to have a year with no negative events), it would make more profit that year, which would translate into more taxes. Of course, such a course of action would be ridiculous. “Shifting profit” by adequately insuring business risks is prudent and tied to the long term viability of any enterprise and its owners. The real difference between insuring some or all risk in a captive and insuring risk with a commercial carrier is that the captive structure may alter where “shifted profit” ultimately resides. Companies that own a captive with built-up reserves (“shifted profit”) are almost always better prepared to manage future risks.
To view the entire letter from CICA and ECIROA to the OECD click the link below.