Clifford Chance

The UK Government is consulting on much anticipated reforms to establish an attractive captive insurance regime. Captive insurance, a self-insurance mechanism that helps businesses to pool and manage risk, has seen significant global growth, yet despite London’s position as a global centre for insurance it does not have a targeted captive regime. The consultation seeks to identify and address regulatory barriers in keys areas such as capital requirements, authorisation processes, and reporting obligations. The proposals are, however, intentionally high-level, with limited specifics at this stage.

Notably, the consultation poses numerous questions to stakeholders, signalling the Government’s willingness to be guided by industry input—an encouraging sign of openness and collaboration. This consultative approach reflects a strategic intent to enhance the UK’s competitiveness and underscores the importance of stakeholder engagement in achieving a framework that is effective and aligned with international standards. It also suggests that lessons may have been learned since the last major new specialist insurance legislation was introduced in 2017 with the UK Insurance Linked Securities (ILS) regime which has struggled to compete in the global ILS market. The consultation is open until 7 February 2025.

Background

Despite the UK having the third-largest insurance market globally and the largest in Europe, it struggles to attract captive insurers, with an estimated 500 UK-associated captives domiciled abroad. This gap is especially concerning given the global expansion of the captives market, which saw 7,000 captives generating $69 billion in premiums in 2021 and is forecasted to grow to $161 billion by 2030. Acknowledging this growth, the Government hopes that by reforming the UK’s framework, it can tap into this lucrative market. The goal is to make captives more attractive domestically, with each potentially contributing £225,000 annually to job creation, taxes, and broader economic activity.

However, the Government faces stiff competition from jurisdictions like Bermuda, Guernsey, and Luxembourg, which already offer tax incentives and take a proportionate approach to capital and regulatory frameworks for captives which is critical and recognises that users of captive insurance are generally not themselves insurance businesses. The UK’s proposals, while lacking tax incentives, are currently too vague to determine whether they can effectively address these competitive advantages.

Proposed Reforms

The consultation outlines several reforms aimed at improving the UK’s appeal to captives while maintaining regulatory standards:

• Proportional Regulation
  
  The Government is advocating for a proportional regulatory approach for captives to alleviate the perceived burdens imposed by the current Solvency II framework. They have recognised that captive insurers present a lower risk to the broader financial system, and the proposal aims to reduce capital requirements, simplify the authorisation process, and ease reporting obligations. The goal is to align the UK’s regulatory framework with the inherently lower-risk nature of captives, which primarily insure internal corporate risks, unlike traditional commercial insurers that assume external market risks and have very limited impact on the broader financial system.
  
  The consultation lacks clarity on the implementation of proposed changes, particularly regarding capital requirements—a critical element for the success of these reforms. To enhance competitiveness, the UK has an opportunity to diverge from capital requirements derived from Solvency II, including the Solvency Capital Requirement (SCR) and Minimum Capital Requirement (MCR) and instead adopts a more tailored approach by adopting capital measures that reflect the unique risk profiles of captives. Introducing a simplified, proportionate capital regime—such as a “Minimum Capital Requirement” (MCR) based on a simple formula or an absolute monetary threshold, as seen in jurisdictions like Bermuda—would provide clarity, consistency, and a more attractive framework for potential captive insurers. The approach to capital requirements will be pivotal in determining the UK’s appeal as a captive domicile.
  
  The Government’s proposals aim to distinguish between direct-writing captives (those insuring risks directly within a corporate group) and reinsurance captives (those providing reinsurance to group members). This differentiation reflects their varying operational structures and risk profiles, allowing for tailored regulation. For example, reinsurance captives often assume a broader scope of risk and may require more robust oversight compared to direct-writing captives, which cover only the internal risks of the group. By acknowledging the nuances of different types of captives, the UK would align itself with global trends where regulators increasingly embrace proportionality principles.
  
  The success of these reforms will require careful implementation and the UK’s reputation for a rigorous authorisation process will need to be addressed. In contrast, jurisdictions like Bermuda and Guernsey are recognised for their streamlined and efficient regulatory approaches. If the UK does not implement these reforms in a timely and transparent manner, it risks falling behind these more agile competitors, potentially limiting the competitiveness the Government seeks to achieve.

• Exclusions and Scope Limitations
  
  The Government has proposed excluding certain sectors from establishing captives including regulated financial firms like insurers, banks and pension funds, which are seen as posing potential financial stability risks if allowed to use captives for self-insurance. Additionally, the proposals prohibit captives from writing life insurance or compulsory lines such as motor insurance. These exclusions aim to reduce the risk of regulatory arbitrage and prevent the creation of captives that could undermine existing insurance markets.
  
  While these exclusions are prudent from a financial stability perspective, they would narrow the potential scope of captives that could benefit from the proposed reforms and would risk limiting its appeal to larger, more diversified businesses that might otherwise contribute to the growth of the captive insurance sector. This could also have the unintended effect of driving UK financial firms who wish to benefit from captive insurance to jurisdictions like Bermuda and Luxembourg, which have broader frameworks that allow for greater flexibility in the types of risks captives can write.

• Protected Cell Companies (PCCs)
  
  One of the most innovative aspects of the Government’s reform proposal is the potential use of PCCs for captives. PCCs allow multiple companies to operate under a single legal entity, with their assets and liabilities segregated into distinct cells. This structure not only reduces the financial and operational barriers to setting up a captive but could also make the model accessible to smaller businesses by enabling them to pool resources and share administrative costs. For firms deterred by the expense of establishing a standalone captive, PCCs could provide a practical and cost-effective alternative, potentially broadening the UK’s share of the global captive market.
  
  The UK already has a PCC framework in place for ILS, which could serve as a foundation for introducing PCC captives. However, successfully implementing such a framework could present challenges. The PRA will need to ensure the segregation of assets and liabilities is robust and the 'fully funded' prudential requirements are consistently met across all cells. The PRA will need to get comfortable with this arrangement, particularly as the framework attracts businesses with diverse risk profiles. Nonetheless, if executed effectively, PCCs could significantly enhance the UK’s appeal as a captive domicile.

• Captive Managers
  
  The Government is considering whether a separate regulatory approach is needed for captive managers and third-party firms that help establish and manage captives. While some have advocated for a distinct regulatory framework to ensure proportionality, the Government believes this would be unnecessary given the low-risk profile of captive business. Many captive managers are already part of existing insurer or intermediary groups, and the Financial Conduct Authority (FCA) can regulate them under the current framework, including the Senior Managers and Certification Regime. This approach would streamline the implementation of a new captive insurance framework.
  
  An alternative option would be to create a new regulated activity specifically for captive managers, which could speed up the authorisation of new captives by pre-approving employees of these managers. However, this approach would require legislative changes, which would take additional time to implement and could delay the rollout of broader reforms.

Opportunities and Challenges

It is very encouraging that the Government recognises the potential benefits of a UK captive regime. The approach taken in the consultation also allows flexibility for stakeholders to shape the framework while leveraging the UK’s proximity to London’s reinsurance hub and its established insurance expertise. These natural advantages position the UK to develop an attractive and competitive environment for captives, offering businesses more effective risk management solutions and stimulating economic activity.

Nevertheless, important considerations remain. The decision to exclude tax incentives, which are a key attraction in jurisdictions like Bermuda and Luxembourg, is significant for firms evaluating domicile options. It is also disappointing that the UK has deemed such incentives unnecessary, as they could have enhanced the competitiveness of the regime. Additionally, the exclusion of financial firms and certain insurance lines may deter participation from large, high-value players.

The Government’s focus on maintaining regulatory integrity while encouraging innovation is critical. To avoid repeating the mistakes seen in the ILS regime—where perceived delays and administrative burdens deterred participation—the Government must ensure that reforms are implemented in a way that is efficient, transparent, and accessible. Drawing lessons from successful jurisdictions like Bermuda, Vermont and Guernsey will be essential for the PRA and FCA to streamline their processes.