Term Explanation: Captive
The term Captive refers, in a legal context, to a special form of self-insurance in which companies establish their own insurance company within the group to insure risks within their own group of companies or corporate group. These insurance models are mainly used by larger industrial companies to reduce risk, control costs, and optimize their risk management.
Captives are mainly found in insurance law, but also in international tax law, corporate law, regulatory law, and sometimes in insolvency law. The legal structure and regulatory treatment depend both on national and international frameworks.
Types of Captives
Pure Captive
Die pure captive (Pure Captive) is wholly owned by a parent company or corporate group and insures only the risks of the parent company and closely affiliated subsidiaries. External risks are generally not assumed.
Rent-a-Captive
A so-called Rent-a-Captive is an insurer that can be used by various companies for a fee without those companies having ownership rights in the captive. A company rents access to an existing captive and shares the benefits of self-insurance with other users.
Group Captive
Die Group Captive is established and financed by several independent companies jointly, in order to collectively insure risks; the participating companies hold shares in the captive.
Legal framework and regulatory requirements
Insurance supervisory law
Captive insurance companies are subject in most countries to Insurance supervisory law, meaning they must be licensed as insurance companies and meet capital and regulatory requirements. In the European Union, the Solvency II Directive (Directive 2009/138/EC) is particularly relevant, as it contains special rules for captives, such as regarding capital requirements and governance.
Corporate law requirements
The formation of a captive requires the selection of an appropriate legal form, usually a stock corporation (AG), limited liability company (GmbH), or equivalents in Anglo-Saxon jurisdictions (e.g., Limited). The parent company must hold at least a majority stake. The articles of association and share capital are subject to the legal requirements of the state of domicile. The choice of domicile often falls on countries with favorable regulatory conditions, known as captive domiciles such as Luxembourg, Bermuda, Guernsey, or Ireland.
Tax law aspects
In international tax law, captives are subject to particular scrutiny, as they can influence profit shifting within a group. Of particular importance are the rules regarding:
- Transfer pricing: The insurance premiums between parent company and captive must comply with the arm’s length principle in order to be recognized as deductible business expenses.
- Transparency requirements: Disclosure and reporting obligations to tax authorities, particularly in the context of anti-BEPS initiatives (Base Erosion and Profit Shifting).
- Tax treatment: The taxation of the captive and the tax recognition of reserves play an essential role.
Civil and liability law
In liability law, captives are considered independent legal entities. Claims against the parent company and against the captive must be legally separated. Insurance coverage provided by the captive replaces coverage from an external insurer, so the legal basis is determined by the insurance contract between the captive and the insured company.
Insolvency law implications
In the event of insolvency of the parent company or the captive, claims against the captive must be asserted separately in the insolvency proceedings. The independent legal status of the captive means that creditors of the parent company generally have no direct access to the assets of the captive.
Purpose and function of captives
Risk transfer and risk management
The primary purpose of a captive is intra-group risk transfer. By establishing their own insurance company, the company can pool and retain risks and reduce market premiums from external insurers. In addition, the captive can provide customized insurance solutions and access coverage for hard-to-insure risks.
Capital allocation and optimization
Through targeted risk management, equity allocation and reserves can be optimized. The captive can be structured in such a way that tax-recognized reserves can be created, which benefits liquidity planning.
Reinsurance function
Captives often act themselves as direct or reinsurers. They can transfer risks to the reinsurance market, thereby flexibly structuring insurance coverage.
International dimensions and choice of location
Captive domicile
A large number of countries have created their own regulatory frameworks for captives—so-called “captive domiciles.” The most popular locations include:
- Bermuda
- Guernsey
- Luxembourg
- Ireland
- Barbados
- Vermont (USA)
- Liechtenstein
These locations often offer more efficient regulation, lower tax burdens, and special legal frameworks for self-insurance companies.
Compliance and governance
Requirements for management
Captives are subject to strict requirements regarding their corporate governance. These include control mechanisms, internal policies, and compliance systems, which ensure transparent and traceable dealings with group-affiliated companies.
Reporting and disclosure
Besides regulatory reporting and notification obligations, captives must meet extensive disclosure requirements regarding premiums, claim payments, and reserves. Frameworks such as Solvency II require regular reports on the risk profile, capital adequacy, and corporate structure.
Legal challenges and development perspectives
The legal structure of captives is continuously evolving. Regulatory requirements, international initiatives against tax evasion, and the increasing demand for transparency raise the expectations for the management and structuring of captives. In the European Union, regulatory requirements are revised on a regular basis to minimize risks in the financial system and avoid market-distorting effects.
Summary
Captives are independent insurance companies for intra-group risk coverage and offer extensive legal structuring opportunities. They are subject to a complex interplay of insurance, corporate, tax, insolvency, and regulatory law as well as broad international requirements. The choice of domicile, structured governance, and compliance with national and international regulations are decisive for the legally compliant establishment and sustainable operation of a captive.
Frequently asked questions
What legal requirements must be observed when establishing a captive insurance company in Germany?
The establishment of a captive insurance company in Germany is subject to strict regulatory provisions under the Insurance Supervision Act (VAG) as well as relevant regulations and directives of the Federal Financial Supervisory Authority (BaFin). First, the captive must apply for a license as an insurance company. Extensive documentation is required, such as a business plan, information about the management regarding reliability and expertise, and proof of initial capital, which must meet the solvency requirements according to Solvency II. The legal requirements also include mandates for corporate governance, risk management, and the internal control system. Reporting obligations to BaFin, particularly with respect to regulatory reporting, must be observed from the outset. For international structures, it must also be checked whether further approvals from foreign supervisory authorities are required. EU insurance law also applies, which is especially relevant for captives that operate across borders and offer services in the European Economic Area or wish to make use of so-called Freedom of Service or Freedom of Establishment rights.
What compliance and documentation obligations exist for captives during ongoing business operations?
Captive insurance companies are subject to the same compliance and documentation obligations as other insurance companies. This particularly includes establishing an effective compliance management system, conducting regular anti-money laundering measures, and complying with data protection requirements pursuant to the GDPR. Insurance regulatory law sets out extensive ongoing reporting requirements to the supervisory authority, including submission of annual financial statements, quarterly reports, and Solvency II filings. Additionally, captives must keep detailed records of all insurance contracts, claims, reserves, and investments so that all business transactions can be audited in the event of a regulatory review. For cross-border activities, additional reporting obligations, such as FATCA or CRS (Common Reporting Standard), may become relevant. Of particular importance is the obligation to document transactions between the captive and the parent company on the basis of the arm’s length principle, to avoid tax risks (especially regarding transfer pricing).
To what extent does insurance law apply to captives, and are there any special features in their regulation?
In principle, the entire body of insurance supervisory law also applies in full to captive insurance companies. However, special features often arise from the fact that captives typically operate exclusively within the group and therefore do not carry out certain activities, such as active insurance business with third parties. This can lead to certain facilitations, such as with reserve requirements or with respect to distribution regulations. Nevertheless, captives are subject to all requirements for solvency capital, own funds, corporate governance (including requirements for the management board), risk management, accounting, and audit, as stipulated by the VAG and the corresponding European regulations. BaFin explicitly reserves the right to impose additional requirements on a case-by-case basis if the structure or business model of the captive presents particular risks to policyholders or the market. In addition, companies with international structures must check which other insurance supervisory regimes may additionally apply.
How is the tax treatment of captive insurance companies in Germany structured?
From a tax perspective, captive insurance companies in Germany are treated as independent insurance companies. This means they are subject to corporate income tax, trade tax, and insurance tax, provided the insurance business is carried out domestically. The tax recognition of premiums received by the captive as business expenses in the parent company must always adhere to the arm’s length principle. This means the premium terms and insurance coverage must withstand the conditions customary for third-party insurance. Extensive transfer pricing documentation and justifications for the appropriateness of the premiums are required. Otherwise, tax authorities may reclassify these payments as hidden profit distributions, which may lead to additional tax assessments. In the case of international structures, the rules on controlled foreign company taxation under the Foreign Tax Act (AStG) may also become relevant, for example if the captive is located in a low-tax jurisdiction.
What are the solvency and capital adequacy requirements for captives?
Captive insurers are required at all times to maintain sufficient own funds to meet the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR) as defined by Solvency II. The amount of required own funds depends on the underwriting risk, market risk, credit risk, and operational risks assumed by the captive. It is particularly important to note that capital requirements are set in proportion to the scope and complexity of the insurance business. The calculation is carried out using either a standard model or—with supervisory approval—an internal model. Furthermore, appropriate measures for continuous monitoring and control of capital must be established. Regular reporting to BaFin on the solvency and financial position is mandatory, and any deviations or breaches of capital requirements must be reported immediately and addressed with remediation measures.
What reporting and disclosure obligations apply to captive insurance companies?
Captive insurance companies are required to provide a variety of reports to both BaFin and the public. In addition to the annual publication of the Solvency and Financial Condition Report (SFCR) and the report to the supervisory authority (RSR, Regular Supervisory Report), regular notifications regarding own funds, technical provisions, premium income, and claims statistics must be submitted. There are also special disclosure requirements regarding the regulatory capital adequacy and risk situation of the company. Once a certain company size or level of complexity is reached, non-financial statements with information on environmental, social, and governance aspects must also be submitted. Compliance with reporting and disclosure deadlines is strictly required, as omissions or incompleteness can lead to regulatory measures up to and including revocation of the license.
What special supervisory requirements exist for international captive structures?
International captive structures must meet the local regulatory requirements in all affected jurisdictions. This relates, for example, to the choice of domicile for the captive, the respective licensing processes, minimum capital requirements, reporting and audit obligations, and tax responsibilities. In the European context, both German and European insurance regulation (e.g. Solvency II), as well as the passporting regime, apply, which under certain conditions allows for business operations in other EU states. For non-EU captives, particular attention must be paid to whether German law requires a license if the captive also covers risks or collects premiums in Germany. In such cases, additional licensing or registration with BaFin may be required. Tax aspects such as double taxation agreements, CFC rules (controlled foreign corporation regulations), and withholding taxes on cross-border payments must also be taken into account when structuring.
