Has the captive industry passed its "sell-by" date? No, says Jenny Hill. It is leaner but more relevant than ever before.

Despite the hype of previous years, there are indications from the domiciles that although captive numbers are still growing, they are doing so at a decreasing rate. New incorporations are down and the net effect after losses depresses the figures further. There are exceptions, of course, and the Cayman Islands have had a bumper year with a net increase of 31. Vermont apparently did well with 27 new captives, but in the end a net figure of only 12. The Isle of Man did well too - surprisingly so considering the maturity of its primary market - with 16 new captives and just two losses. Elsewhere growth is decidedly muted.

Is this the beginning of the end, or just a blip? Will the captive industry recover the heady growth rate of 20% or will domiciles simply recut the existing "cake" by offering redomiciliation opportunities?

The proliferation of new domiciles (The Canaries are the latest to consider setting up a special zone) indicates that at least some believe there are many more captives to be had and they are probably correct. Jim Costin, the Gibraltar supervisor said recently that he expected 40 captives in his domicile by year end. As Gibraltar currently has five, that is a very positive statement.

The industry is going through a difficult period with saturated primary markets, low transfer rates and a time lag for new geographical areas. But it is proving flexible enough to combat the pressures put upon it, and inventive enough to stay ahead of the competition. However, growth is likely to slow further while mature markets like the United Kingdom and Sweden decline, and before new markets such as Latin America open up fully. The United States is enjoying steady growth with some rationalisation.

Source of past growth

Traditionally, growth has come from "standard" captives underwriting property/casualty programmes, supplemented from time to time with "surges" from special situations where profits could be made or external markets had failed. Standard captives are vulnerable to soft markets, and special situations are limited by the number of companies in the sector. In adverse conditions in either case, the growth in the number of captives will fall.

The UK and Sweden are the dominant markets in Europe with over 500 and 100 captives respectively. That shows great penetration, and it is hard to see where new standard captives could come from. In the UK, special situations have involved customer insurances linked to a core product for retailers, privatisation of the major utilities which produced large corporations used to high levels of self-insurance and mortgage indemnity insurances when the external markets failed on price.

Customer insurances are under attack from the tax authorities, and it is unlikely that captives will be set up in quite the same way in future for UK owners. Privatisation in the UK is largely complete. It produced a lot of captives - both standard and customer-orientated - but the process is now over. To make matters worse the sector is now subject to merger and take-over activity, reducing the number of principals. New owners are reviewing the validity of existing captives and their need (or not) for a multiplicity of insurance vehicles. Although the amount of business remains the same if captives are merged, the number reduces and some of the statistics reflect this.

Mortgage Indemnity opportunities are also finite in any one country, depending as they do on the number of financial institutions requiring the cover. Here, too, traditional building societies in the UK are demutualising and either buying other banks or being bought themselves. Again, a reduction of the number of captives is the likely outcome as the sector rationalises.

Where will new growth come from?

The establishment of a captive depends among other things upon alternative products, economic conditions and acceptance of the concept in the locale by potential owners, regulators, insurers and brokers.

For some years captives had little competition from alternative products. They were a way of clawing back profit from an industry that had high costs and many inefficiencies, little (of the right) technology and a tendency for knee-jerk reactions on price.

The biggest threat to captives today, is fierce competition from that very same industry - now offering very low prices for an extended period. Few pundits had predicted that the soft market would still be with us today. In prior cycles it was easy to sell the captive on the volatility issue alone, but now even those finance directors who take a long term view are at last succumbing to the siren's song of the soft market. As a manager in Guernsey said: "There are many feasibility studies being done but fewer are being converted into actual captives, so although the interest is still there, there is not that much new business for us."

Ironically, the very soft markets have resulted in more captives being formed in some circumstances. Excess capacity has not just reduced prices - it has led to price differentials which can be exploited though a captive. Some insurers are willing to undercut prices "behind the scenes" and achieve this by awarding over-riders to a non-retention captive. Sometimes markets will react in different ways and the captive can be used to arbitrage between them, taking the best of each - a claims lead from the traditional market, perhaps, and a cheap price from the excess of loss market.

Reinsurers, too, are behaving more like direct insurers and are competing directly, moving closer to their target clients by offering long term relationships, multi-line programmes and low prices accessible through a captive. Dublin's growth, the interest in Gibraltar's new legislation and in Lloyd's as a home for captives show that the clients are keen to profit from this development. They are also keen to have more control of their programmes, some fearing the oligopolies that may result from the merger activity elsewhere in the sector.

This raises an interesting point. Control is all very well but a fronting captive does have to supply a lot of services hitherto bought within the deal. These may need to be outsourced on an unbundled basis or captives will have to grow sufficiently to provide them themselves. Technology and relationships with worldwide service providers will be key to the future development of such sophisticated captives.

Tax moves

Many sponsors' domiciles remain antagonistic towards captives and continue to search for ways to reduce the fiscal benefits enjoyed offshore. In the UK, the proposed accounting standard FRED 14 relating to non-specific provisioning is sending shivers through the industry, and the Inland Revenue continue to chip away at the lower end of the insurance spectrum, making it non-cost effective to insure the more predictable losses in a captive.

Instead, these are now being financed as self-insurance funds, though it is possible that the Revenue will attack these too and impose a form of self-insurance tax. If that is the case, the captive will be back on a level playing field and the preferred option, if only for the management information it produces.

Problem solving captives

Although special situation captives are limited by the number of players in the sector, the application of the expertise can increase the number of captives worldwide if applied in new geographical areas. In the US for example the number of mortgage captives is still increasing - Vermont had one in 1995, three in 1996 and seven in 1997 - contrary to the trend in the UK.

Captive opportunities in Latin America and the Far East will more than fill the gap left by mature markets but may not do so in a time frame which produces uninterrupted growth. There will be a slow down because any new market must be educated in the product and that takes time. The captive concept has to be sold to all the participants in the industry, especially where this has been a highly protected environment. Economic growth in Latin America is good and interest in the product high, making it fertile ground for captives but there are difficulties where governments seek to protect their home industries and their foreign exchange positions.

The Far East has its special problems right now and companies are unlikely to focus on retaining risk that they can in any event shed cheaply in the short term. In the longer term, though, this should also be a growth area for captives, as corporate structure tends towards the large conglomerate. There is a low propensity to insure here but this may result in captives positioned at a more effective level, taking real risk rather than the dollar swapping variety.


The captive industry has not passed its "sell-by" date - far from it. Growth might not be exponential today but in the changing environment there are more opportunities than threats. Internal growth for existing captives may not be reflected in the numbers but increased premium and funds under management will illustrate this.

A wider application of existing knowledge will enable sponsors in Latin America, Europe and the Far East to set up captives as part of a risk financing strategy, based on over 20 years of experience elsewhere. Deregulation will allow new participants to design products specific to their area and their circumstances, and the new relationships that may result with insurers, reinsurers and other service providers will redefine the way that captives are used. They are definitely here to stay.

Jenny Hills is associate, Willis Risk Solutions, London. Tel: +44 (0)171 488 8866. Fax: +44 (0) 171 488 8218. e-mail: hilljj@wcg.co.uk