Bermuda Captive Seminar RIMS New York Chapter September 16, 2010

1. Bermuda Captive Seminar RIMS New York Chapter September 16, 2010

2. Panel Beverley Todd, Executive Vice President, JLT Insurance Management (Bermuda) Ltd. Carol Feathers, Managing Director Appleby Management (Bermuda) Ltd. Neil Horner, Head of Corporate, Attride-Stirling & Woloniecki Richard Irvine, Tax Partner, PricewaterhouseCoopers Bermuda Shelby Weldon, Director, Insurance Licensing & Authorisations Bermuda Monetary Authority

3. Agenda • Why Bermuda? • 2. Why companies form captives and latest captive uses • 3. How to form a Captive • 4. Captive Tax Update • 5. Bermuda’s Captive Regulation

5. Why Bermuda? Beverley Todd, Executive Vice President JLT Insurance Management (Bermuda) Ltd.

6. Why Bermuda • Largest captive domicile • Blue chip offshore financial centre • 3rd largest insurance centre worldwide • One stop shop – access to insurance and reinsurance • markets • Robust yet flexible regulatory environment • Professional infrastructure • Quality of workplace • Key geographical location • Competitive prices • Segregated Accounts & SPI Legislation • No Income or Capital taxes

7. Why Bermuda – Largest Captive Domicile

8. Why Bermuda – Captive Formations Source: Bermuda Monetary Authority, Report of New Incorporations Dec 2009 * Includes Class 3A; 3B & Composites

9. Why Companies Form Captives

10. What is a Captive? • Insurance subsidiary of a commercial/financial company, or a consortium or an association of individuals • Formed to primarily insure or reinsure the risks of its parent, or of a number of parties with risks in common or unrelated risks • Usually formed in a specialized environment or “domicile” – “onshore” or “offshore”.

11. Types of Captive • Single Owner • Multi-owner or Association • Rent-a-Captive – multiple non-owner • Protected or Segregated Cell Captive (PCC, SPC SAC) – any of the above

12. Why Form a Captive? • Reduce the Total Cost of Risk • Risk Management Reward & Focus • Direct Reinsurance Market Access • Additional Capacity • Flexibility in Program Design • “Uninsurable” Risk • Profit Centre • Information and Control

13. Traditional Uses of Captives • Traditional risks: • Workers Compensation • Auto Liability • General Liability • Expected Losses over $1 million • Long tail covers seeking tax advantage

14. Traditional Uses of Captives

15. Traditional Uses of Captives

16. What are the disadvantages? • Capital commitment - the captive’s capital is not available for use in the parent’s business • Adverse results - the captive’s capital can be eroded by adverse results under the insurance program • Operating costs - a captive does incur operating costs and demands a time commitment from senior management

17. How a Typical Captive Operates Parent Corporation Or Association Captive Board Management Company Auditors Lawyers Regulators Investment Managers Bankers • Control of the captive will be by an appointed board of directors, usually a mix of local professionals and parent company workers • The board then appoints local companies for services like banking, auditing etc • Management company carries out all operational functions on behalf of the captive and provides insurance and other expertise that is required by the captive

18. Captive Service Providers

19. Latest ideas on Captive use Carol Feathers, Managing Director Appleby Management (Bermuda) Ltd.

20. Current Environment • Continued soft market • Interest rates low • Below average return on investment • Inflation on the rise • Cash/liquidity still an issue • Restricted credit, squeeze on collateral

21. Current Captive Market • Incorporations continue • Changing regulatory environment • Economic environment driving strategic review and uses • Owners are: • identifying untapped potential cost-saving mechanisms • increasing retentions • accessing excess capital • considering new lines of coverage

22. Where is the business coming from?

23. Expenses • Benefits • Retiree’s Medical • Health Insurance • Group Life – Company owned life insurance • Pension • Long Term Disability • Short Term Disability

24. Income • Product Contamination / Product Recall • Owner Operator – Occupational Accident • Extended Warranties

25. Assets • Cyber Risk • Reputational Risk • Residual Value • Trade Credit • Wealth Transfer

26. Liabilities • Bailee Coverage / Storage Facilities • Products Liability / Efficacy Combined • Professional Indemnity • Medical Malpractice • Legacy Liabilities

27. Other Interesting Developments • Segregated Cell Conversion • License Class Changes • Risk Management Funding • Challenging Program Design • Collateral Considerations

28. Outlook • Indications that P&C market will stay soft • Organizations continue to assess the value of every $ spent • Focus on optimizing risk • Evaluate placing less coverage in the commercial insurance market and increasing retentions • Combat high cost and availability of collateral • Increase in global regulation

29. Conclusion Captives as a strategic risk financing tool are continuing to evolve and deliver benefits to the parent company in many areas, not just insurance and tax.

30. How to Form a Captive Neil Horner, Head of Corporate Attride-Stirling & Woloniecki

31. Professional Services Team

32. The Incorporation Process Steps to Licensing 1. Select Service Providers 2. Application to Incorporate and License 3. Incorporation, Organization and Capitalization 4. Register as an Insurer Captive Insurance Company

33. The Incorporation Process Step 1: Choosing Service Providers • Insurance Manager / Principal Representative • Auditors • Actuary (if required) • Legal / Corporate Secretarial

34. The Incorporation Process Step 2: Application to Incorporate and License • Incorporation Submission • Registrar of Companies; and • Bermuda Monetary Authority: • Authorisation and Compliance Division Insurance Submission • Bermuda Monetary Authority: • Insurance Division • Assessment & Licensing Committee (ALC) • Technical Advisory Group (TAG)

35. The Incorporation Process Step 2 Continued • Description of Shareholder • Description of Insurance Business • Lines of business to be written • Layers to be written • Fronting arrangements • Retention levels • Reinsurance Program • Investment Strategy • Directors • Service Providers • 5 year financial projections

36. The Incorporation Process Step 3: Incorporation, Organisation & Capitilisation • Incorporation • Receipt and filing of consent • Organization • Directors and Shareholders Meetings to: • Issue shares • Approve bye-laws • Appoint auditors • Appoint insurance managers • Other formalities • Capitalization

37. The Incorporation Process Step 4: Registration as an Insurer • File formal application with the Bermuda Monetary • Authority • The formal application should be the same as, or • substantially similar to, the pre-incorporation application Your Bermuda team of Professional Service Providers will lead you through steps 1 through 4

38. Captive Tax Update Richard Irvine, Tax Partner PricewaterhouseCoopers Bermuda

39. Benefits of a properly structured captive • In general reserves accrued for retained risks are not deductible for U.S. Federal income tax purposes (cash basis). • Insurance premiums paid to a properly structured captive insurance company to fund retained risk should be currently deductible if coverage period of 12 months or less. • A captive insurance company can set up deductible insurance reserves. • Insurance premiums can generally be paid across borders to fund risk exposures and create local deductions. • Withholding tax versus Insurance Premiums Tax (IPT) • Properly structured captive insurance arrangement generally accepted as a method of risk management.

40. Definition of Insurance for U.S. Federal Income Tax Purposes • “Insurance” is neither defined in the statute nor the Treasury regulations. • Judicial precedent provides the following framework for evaluating whether a scenario is an insurance arrangement (LeGierse): • Presence of insurance risk • Risk shifting • Risk distribution • Commonly accepted notions of insurance • Common Structures • Parent/Subsidiary (Carnation, Clougherty Packing) • Brother/Sister (Humana, Kidde, Malone) • Third-party risk (AMERCO, Harper, Sears)

41. Definition of Insurance for U.S. Federal Income Tax Purposes • Parent/Subsidiary • Premiums • Parent has not shifted its risk to Captive. • Balance sheet approach • Revenue Ruling 2002-89 • Premiums paid from Parent to Captive are not deductible. • Captive is not considered an insurance company. Parent Captive

42. Definition of Insurance for U.S. Federal Income Tax Purposes • Brother/Sister • Parent • Parent has not shifted its risk to Captive. • Balance Sheet approach • Premiums paid from Parent to Captive are not deductible. • Subs • Subs generally shift risk to captive. • Premiums paid from Subs to Captive are generally deductible provided certain bona fides are • satisfied: premiums are arm’s length, the Captive is adequately capitalized, and the Captive is not • propped up. • Captive • Generally treated as an insurance company. Parent Premiums Subs Captive Subs Premiums

43. Definition of Insurance for U.S. Federal Income Tax Purposes • Third-Party Risk • Parent • Parent generally shifts its risk to Captive, provided sufficient third-party risk is present. • Third-party risk benchmark > 30% of total premium • Premiums paid from Parent to Captive are generally deductible, provided bona fides are satisfied. • Subs • Subs generally shift risk to Captive. • Premiums paid from Subs to Captive generally deductible, provided bona fides are satisfied. • Captive • Generally treated as an insurance company. Third-party Risk Premiums Parent Premiums Subs Captive Subs Premiums

44. Examples • Summary • Scenario should qualify as a brother/sister insurance arrangement provided the bona fides are present. • Premiums paid from U.S. Subs to Captive should be deductible. • Captive should be treated as an insurance company for U.S. federal tax purposes. • Primary Benefits • Capital is minimized by pooling risks. • Management of risk is centralized. • U.S. federal and state tax deductions should be accelerated creating increased cash flow. • Investment earnings not subject to U.S. federal or state taxation. • Funds are moved from the U.S. to a tax efficient jurisdiction of the Foreign Parent. Foreign Parent Subs Captive Non US Domicile U.S. Subs * Premiums * Note: U.S. federal excise tax likely to apply.

45. Tax Update RECENT CHANGES

46. Uncertain Tax Position Disclosure • The IRS announced on January 26, 2010 a proposal that would require certain businesses to provide information about their uncertain tax positions identified in their accounting statements; e.g. FIN 48 (primarily codified in ASC 740-10). • The Service intends the new schedule to be filed by a business taxpayer with total assets in excess of $10 million if the taxpayer has one or more uncertain tax positions. • Schedule will be filed with Form 1120, U.S. Corporation Income Tax Return, or other business tax returns.

47. Uncertain Tax Position Disclosure • The Schedule will require • A concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve • The maximum amount of potential federal tax liability attributable to each position (determined without regard to the taxpayer’s risk analysis of its likelihood of prevailing on the merits). • “Concise” and “Maximum tax liability” are further embellished. • Significant commentary was provided to the Service

48. Uncertain Tax Position Disclosure • Announcement 2010-30 • IRS unveils draft Schedule UTP, Uncertain Tax Position Statement, and instructions • For each identified uncertainty, calculation of the MTA (Maximum Tax Adjustment) will be required on an annual basis: • The draft instructions provide a detailed description of how to calculate the MTA • For transfer pricing and valuation positions, can use a “ranking” approach • A response on the question of penalties is outstanding, however one option is to seek legislation from Congress to impose new penalties for failure to file the form or to make adequate disclosures.

49. United States v. Textron Inc. • First case to test the new aggressive position the IRS is taking regarding the request for tax accrual workpapers. • The First Circuit vacated the district court’s determination that a public corporation’s tax accrual workpapers were protected from IRS summons by the work-product doctrine. • The First Circuit held that the work-product privilege was not implicated with regards to the taxpayer’s tax accrual workpapers, because it found that the work papers were not prepared “for” litigation and were thus required to be produced pursuant to an IRS administrative summons. • Next Step: Currently before Supreme Court on a petition for certiorari

50. Codification of Economic Substance • On March 18, 2010, The “economic substance” doctrine (IRC §7701(o)) became law as part of the Hiring Incentives to Restore Employment (“HIRE”) Act. • States that “in the case of any transaction to which the economic substance is relevant, such transaction shall be treated as having economic substance only if: • (a) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and • (b) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction.”