A hard market, made more so by the events of September 11, has prompted a wave of new interest, at record levels, in the captive insurance sector worldwide. At a round table discussion on the industry held at the Grand Old House in Cayman, representatives of the local insurance managers, banks, professional firms and regulatory authorities commented on a very active year and predicted a similarly bright future.
Roger Crombie: Would each of you introduce yourselves?
Henry Smith: I am a partner at Maples and Calder, Cayman's largest law firm. We specialise in all aspects of offshore financial work, including insurance. My personal experience has been related to advising Cayman Islands insurance companies that are developing variable rate annuity policies and other insurance products. I have also been working on capital market programmes for onshore insurers who are accessing the capital markets using Cayman Islands note and bond issuing companies.
Morag Nicol:I am deputy head of the Insurance Supervision Division at the Cayman Islands Monetary Authority. This regulatory division is primarily responsible for monitoring compliance with all relevant legislation and ensuring the solvency of insurance licensees in the Cayman Islands, ultimately providing protection to policyholders and other interested parties.
Charles Bolland: I am a partner with PricewaterhouseCoopers, primarily dealing with insurance. I am one of two insurance partners at the firm in Cayman responsible for performing the audits of clients who are licenced insurance companies.
Paul Lumsden: I am also a partner at Maples and Calder, in our company commercial group, involved in all aspects of offshore work, including insurance. My experience in that area relates mainly to the licencing of insurance companies and catastrophe bond deals.
Marcus Stafford:I am a manager with Royal Bank of Canada, in charge of a team that looks after banking services, including investment, custodial and credit services for captive insurance companies in Cayman.
Wayne Cowan: I am managing director of JLT Risk Solutions, part of the Jardine Lloyd Thompson group. My previous experience includes running the Johnson & Higgins and Marsh McLennan operations in Cayman. We are captive insurance managers; we put together captive insurance programmes and feasibility studies and make reinsurance placements.
Ron Sulisz: I am senior vice president with Marsh Management Services Cayman Ltd. We are the largest insurance managers in Cayman, with over 160 companies presently managed.
Tom Clark: I am a director of HSBC Financial Services. We are part of the HSBC group and captive insurance managers.
Roger Crombie: Mrs. Nicol, can you tell us what has changed in the area of insurance legislation in Cayman in the past 12 months?
Morag Nicol: We have benefited from continuing improvements and changes in legislation. A welcome change in our legislation came in April of this year, when we saw additional enforcement powers put in place, which significantly extended our pre-existing powers. We are very encouraged to have these new powers, although we do not expect that we will need to utilise them very often. It is, however, very important to have these regulatory tools. The new powers include, inter alia, the ability to issue cease-and-desist orders; to remove a director, officer or manager; to impose conditions on a licence, and to appoint a controller or a liquidator. These new powers provide very positive options as far as regulatory action is concerned.
I would also like to mention that just over a year ago new legislation was introduced regarding `know your customer' requirements. The new legislation formalised a considerable number of procedures that were already adhered to in practice with regard to such matters as the approval of director, officer and manager appointments. The new legislation also sets out clearly the approval requirements relating to shareholders. This change now makes it clear to all what the requirements are and confirms that we are adhering to recognised international standards in this area.
Roger Crombie: Your division is in the process of becoming independent, although it is taking a little longer than had been hoped.
Morag Nicol: We are taking our time to make sure that when the Cayman Islands Monetary Authority, of which the Insurance Supervision Division is a part, becomes independent that the timing is right to do so and that everything is in place for a smooth transition. We see independence as a very important and positive step, ensuring that we are detached from any possible political or governmental influence that might possibly hinder the operations of the Authority. It is important that the `outside world' is able to see that we operate in the same environment as many other international regulatory bodies. In reality, as far as the administration is concerned, it will not make a huge difference to the process. At the moment, we make recommendations to Executive Council, that is the executive arm of government, with whom responsibility for approval rests in respect of regulatory decisions. With independence, we will be able to make all regulatory decisions and fully implement them.
Wayne Cowan: Do you think, Morag, that it will make the licensing process even quicker?
Morag Nicol: Yes, I do. As far as licensing is concerned, it is an efficient and speedy process at the moment, generally taking around four weeks from receiving a complete submission, but independence of the Authority may take as much as two weeks off the whole process.
Paul Lumsden: The speed with which the Authority process licence applications is an important factor for clients and this development is likely to increase Cayman's attraction as a jurisdiction in which to carry out insurance business.
Roger Crombie: A question perhaps for only some of you: does regulation in the Cayman Islands work, for those who have to deal with it? Is it a practical system?
Wayne Cowan: From my point of view, yes. We have had very few problems with the regulatory authority here. I think that the granting of additional powers is a positive, rather than a negative, because previously the regulatory authority really had very little power in the case of an insurance company that was acting outside its business plan. If we had problems, we could do very little. So we view the changes as a very positive development. The managers have a very close working relationship with the insurance regulator.
Ron Sulisz: I believe that, relative to some of the other domiciles, where they tend to regulate more on the basis of defined ratios, having the Monetary Authority focus on a submitted business plan for each company makes it more flexible to be able to accomplish a variety of things. It makes greater business sense.
Morag Nicol: I would suggest that one of the other reasons why it works is because of the involvement of experienced insurance managers. Particularly with regard to the licensing process, when the Authority considers submissions for a proposed new captive, the insurance managers have already worked with the potential new licensee and given direction on the content of the submission. Accordingly, the considerable experience of the insurance managers is reflected in the thorough submission presented to the Authority. So, in almost all cases, we are provided with comprehensive detail from the submission, which means we generally have only a few questions or points requiring clarification and thus can proceed with the licensing process quite quickly. Having the benefit of seeing all the groundwork being done well makes our job a lot more straightforward. We also recognise that we have the benefit of very knowledgeable staff in the Insurance Supervision Division, many of whom have in the past worked `on the other side of the fence' in the insurance industry. As a result, they know what to look for from a technical point of view and also know what makes sound business sense. Cayman therefore benefits from experienced individuals, both on the regulatory side and the private sector.
Roger Crombie: Bankers are subject to `know your customer' rules. How do the rules apply to the insurance managers?
Wayne Cowan: The due diligence that we have to perform is very similar to what the bankers have to perform - and quite rightly so. We have very, very strict `know your customer' guidelines. So we are the first line of defence, and then, I imagine, the Authority has its own due diligence procedures, which are the second line.
Morag Nicol: Yes, indeed. The Authority carries out its own `know your customer' checks.
Roger Crombie: In the last three years, we have seen a variety of initiatives aimed at the offshore community, led by the Organisation for Economic Co-operation and Development (OECD). Is it the general view that those initiatives have been beneficial to Cayman, in that having passed muster, Cayman now has a stamp of approval?
Henry Smith: Certainly, for Cayman to have been subjected to these types of review processes by various international organisations, with positive results, has been helpful in enhancing Cayman's reputation as a premier jurisdiction in which to do all types of financial services business, including investment funds and capital markets-related business, as well as insurance. Wherever possible, Cayman has tried to respond quickly and positively to recommendations to improve any existing legislation to meet international standards. For example, Cayman has now built upon its existing anti-money laundering legislation with detailed regulations and guidance notes in the area of `know your customer'. Although many of the financial institutions already had in place internal group `know your customer' procedures, financial institutions operating in Cayman are taking steps to comply with these new, more formalised requirements by, amongst other things, upgrading account opening procedures and documentation and software databases and hiring compliance officers to monitor their business.
Roger Crombie: Has it had the effect of reducing your business?
Henry Smith:It has not reduced our business, no.
Wayne Cowan: I think that the major concern that many of us have with the never-ending round of inspections is whether we are being held to higher and more rigorous standards than perhaps the United States or the United Kingdom. Are we playing on a level playing field? Perhaps that is a concern, and perhaps it is not. But, certainly, we have been under the microscope. The subjective application of higher standards could be perceived as unfair.
Roger Crombie:The famous `level playing field'. You really do not have much choice, do you? You have to comply.
Morag Nicol: We welcomed the opportunity to have these various international bodies come and review the jurisdiction. Apart from anything else, such a review involved being judged on a standard similar to other jurisdictions. Certainly, referring to past reviews such as the KPMG review, which covered the British Overseas Territories, the resultant outcome was that we received a very positive report. The report provided a focus for our ongoing regulatory development and was useful from a public relations point of view, as it allowed us to direct individuals, who were not particularly knowledgeable about the jurisdiction, to the report, to give them an increased level of confidence.
Roger Crombie: Is the US Patriot Act going to cause anyone here a problem?
Charles Bolland: My sense is that a lot of the changes we have gone through in the last few years have actually put Cayman in fairly good stead in terms of the Patriot Act. A lot of the changes that have been implemented, which are things that were happening before being formalised into law, will actually help us in terms of the Patriot Act. There is significant crossover in what is being required under the Patriot Act and what we have gone through in the last couple of years.
Henry Smith: In some respects, Cayman seems to have been a little ahead of the curve, in having already introduced its `know your customer' regulations. The Patriot Act has now obviously focussed US financial institutions' and service providers' attention on this whole area of collecting `know your customer' materials. The concern was, I think, for a time, that Cayman service providers were going to have to ask for detailed information and verification materials about their clients, which might not have been required to the same degree by US onshore financial service providers, but this is not so much of a concern now that the US onshore service providers have to comply with similar requirement under the US Patriot Act. There now seems to be a great deal of cooperation between the service providers and clients and acceptance that the `know your customer' procedures are simply now a routine part of doing business.
Roger Crombie: Is everyone here very busy right now?
Morag Nicol:The insurance industry worldwide is very busy and Cayman is no exception. We have been particularly busy this year, as indicated by the number of new licences that we have issued. At the end of the third quarter, we have licensed 63 new captive insurance companies, which is a record. Obviously we are very pleased with that number. It brings us to 577 active companies in total. Most significantly though, it is not just growth that counts but the quality of that growth. The new companies that we have seen come to us are very well capitalised, very well funded. That is a reaction to what we are seeing in the commercial marketplace, namely the hard market. For that reason, we are very comfortable with the type of company that has chosen to domicile in Cayman. I predict that this phenomenal growth will continue, certainly for the remainder of 2002 and the early part of 2003. So, yes, we are very busy and accordingly the insurance managers and other related service providers are also very busy.
Ron Sulisz: From our perspective, we have added 26 new clients in our office this year. We have several new applications that we anticipate will be licensed before the end of the year. Also, we are seeing a lot of existing captives adding additional lines of insurance to their business plans and we are seeing companies that had previously been placed in voluntary run-off become active again.
Wayne Cowan: Our experience is very similar. When we formed JLT, about a year and a-half ago, we obviously had concerns about where our new business was going to come from. The reality of the hardening market and the events of September 11 has been to resolve those concerns quite dramatically. As Morag alluded to, a striking characteristic of the business that we have seen has been its quality. These are highly-capitalised corporations, big names with substantial capital and well-financed programmes. I expect this to continue for the foreseeable future.
Marcus Stafford: And, of course, that has a knock-on effect in the banking industry. The new business that flows from the captive side naturally flows through to the banking side. We would echo the fact that we are very, very busy as well.
Roger Crombie: This new business is coming primarily from the US?
Wayne Cowan: Yes, primarily from the US, in our experience.
Ron Sulisz: US Healthcare continues to be our leader. Typically, healthcare runs at approximately a third of Cayman captive business, however I believe this year it is above that level, at slightly above 40%.
Morag Nicol: For 2002, US healthcare-related captives account for just under 50% of all new captives licenced. It is interesting to note that that percentage has increased from the traditional 33% portfolio share of past years.
Wayne Cowan: What is also interesting is the impact that the hard market is having with respect to where our new business is being generated from. A few years ago, our new business would originate primarily from the traditional industrial states such as Massachusetts, Illinois, Michigan and Pennsylvania. Now we are seeing business from states such as Alabama, Mississippi, Nevada and Arizona. So the concept of captive insurance is moving across to geographic regions that, 10 years ago, would not even have considered setting up a captive insurance company.
Charles Bolland: One thing very recently that I have seen - and I am not sure if Morag has seen this yet, or whether it is still in the pipeline - is a couple of new captives coming out of South America. Both are significant programmes, very large companies. That has been an area, where Cayman has hoped to experience some growth, given the number of Brazilian banks that are in Cayman and are familiar with Cayman's regulatory environment and the level of professionalism of the services provided here. Hopefully, that will be a continuing trend.
Morag Nicol: I expect that the percentage of new business that we obtain from North America will continue to represent approximately 85% of the Cayman portfolio, although I believe it is likely that the worldwide attraction of captives will increase and Cayman will undoubtedly facilitate the domiciling of a share of these captives. In 2002, we have seen an increase in the number of Latin American applications. Predominantly, though, I think that Cayman will remain of interest mainly to the North American market.
Roger Crombie: A number of states, as many as 19, I think, are now operating their own captive programmes - but the companies are coming here. That, presumably, says something about the quality of service available in Cayman.
Wayne Cowan: I believe Arizona was the last state I had heard of to enact captive legislation. We have a couple of Arizona captives here in Cayman. I believe there are two primary reasons as to why they are unlikely to redomicile: firstly, the quality of service that the clients receive in the Cayman Islands; secondly, a concern that these initiatives do not actually have the enthusiastic support of insurance regulatory bodies in the various states. Furthermore, even if there is support now, what happens when a new state regulator is voted in? Is the support still there? Our clients understand that by staying in the Caymans, they will continue to save themselves a lot of red tape and bureaucracy and continue to receive the level of service and attention that they are used to. I really do not see the domestic captive jurisdictions as providing too much competition to the offshore captive market.
Ron Sulisz: What we are seeing is that Cayman is a proven product, something that has been successful in the past and is well understood. So, why try to create something new? Why be the first one in a state, if you are not sure exactly what will happen?
Wayne Cowan: New York tried it a few years ago. They had a major launch at one of the captive insurance conferences, three or four years ago. The representatives stood up and said: `New York is ready for captive business'. Since that time they have had one captive, which I think is the State transport authority. I do not believe they have the wholehearted support of the insurance regulatory bodies there.
Morag Nicol: I believe that those who are trying to set up captives in today's world are, quite rightly, placing a lot of weight on the fact that Cayman has a recognised level of expertise that has been developed over the years, both in the regulatory field and the private sector. This provides them with a level of confidence in selecting Cayman as the jurisdiction of choice for their captive.
Roger Crombie: So who is your competition?
Ron Sulisz: Bermuda is the largest captive domicile and Cayman is the second largest, so I guess you can say that Bermuda is our competition.
Tom Clark: We are beginning to see some competition from other areas in the Caribbean.
Morag Nicol: As far as healthcare-related captives are concerned, Cayman continues to be the number one jurisdiction. So in that area, Cayman is everyone else's competition.
Roger Crombie:Tom, how is the securitisation business these days?
Tom Clark: There are not as many insurance companies being licenced for securitisation business, but there are still a lot of deals being done, if you think about swaps, as opposed to insurance contracts. Those companies are not licensed as insurance companies, however. But the concept of having a company that is bankruptcy-remote and which is fully-funded in the total amount of the coverage being provided remains very, very attractive to the cedant. In fact, it is more attractive now than it has ever been, given the state of the insurance market. It lets the cedant place more faith on the credit risk of the specialised bankruptcy-remote entity than they can on the traditional reinsurance market, so that is driving a lot of new business.
Roger Crombie: What clouds are on the horizon for the Cayman insurance industry? What concerns do you have?
Ron Sulisz: At the present moment, I think everything is going very well. We have gone through so many of these different international initiatives, and passed the grade everywhere, that this seems to be a good time for the Cayman insurance sector.
Tom Clark: One of the tests was: would we see new captives when there was a soft market? Would we see new interest at such a time? And the answer to that was: yes. There was a lot of interest last year and a good number of incorporations the year before, something like 45 or 47 new companies in what was a very tough market. Those were captives formed for strategic reasons. They were not formed as part of a knee-jerk reaction to the state of the market. The business continued to thrive and prosper through a very, very long period of a very soft market. We are now back to the hard market, such as there was in 1976, or 1986, and we are seeing more than 50% growth in captive formations. So, the thing that would worry us the most, in terms of the business, would be a soft market. That could cause us enormous problems, if we were unable to survive it. At the moment, though, it is all hands to the pumps to make sure that we can deal with the new business that is coming in. One of the questions we used to be asked was: "If there were a hard market, could the infrastructure deal with all of the new company formations and all of the management requirements?" And the answer to that is obviously yes.
Roger Crombie: Is the hard market here to stay for a while?
Ron Sulisz: This is supposed to be a cyclical business. We had a prolonged soft market. Does that mean that we are going to have a prolonged hard market to make up for it? Who knows? But I doubt that things will turn around in the immediate future.
Tom Clark: There is nothing in the results that have been coming out from the traditional insurance companies that indicates that any of them are enjoying enhanced performance. No one is forecasting a huge pick-up in investment returns. No one is writing business for a return based on investment income. The traditional insurance markets are struggling to remain sufficiently capitalised. When we see that sort of thing happening, we do not see in the short term any insurance company basically giving coverage away, which is what was happening two years ago.
Roger Crombie: So the influx of capital to the industry worldwide after September 11 has not had a dampening effect?
Tom Clark: Not at all. You asked earlier about what might restrict captive formations, or adversely affect our business. One situation would be where it became difficult to obtain reinsurance. There are some programmes that perhaps have not occurred because reinsurance has not been available, or an existing captive has stopped writing business due to lack of reinsurance. So, to the extent that there was an influx of capital after September 11, that has probably helped our business by making reinsurance available that would not have been there otherwise.
Charles Bolland: Which is an issue that is not just specific to Cayman, but to any captive domicile.
Wayne Cowan: It is still very difficult getting fronting paper, and when you do find it, it is incredibly expensive.
Roger Crombie: Is Cayman looking to attract physical presence companies to its shores?
Wayne Cowan: If you are talking about the big reinsurance companies, then I suspect that Cayman would encourage the ACEs and XLs of this world to set up here in Cayman, which would make us more of a real insurance player on the world stage. But as insurance managers, no, I do not think we would feel particularly encouraged by more companies setting up down here, purely to write their own insurance. Certainly, though, one or two major carriers coming down here would be a wonderful boost to Cayman.
Roger Crombie: Of course, ACE and XL are already registered here. The reason I ask is that there are those in Bermuda saying it is full. Would Cayman be the logical next place if Bermuda were to declare itself full?
Wayne Cowan: I think it has to be.
Ron Sulisz: I think it might make sense, in particular, to the excess reinsurers in the healthcare business. With there being so many healthcare captives here, they could have their captive meeting here and meet with the excess reinsurers at the same time.
Morag Nicol: It could be seen as a natural progression because Cayman already has a pool of insurance expertise and has already proven itself to have the infrastructure in terms of all the necessary support, such as roads, air links and the hotel industry. In addition, on the business side, Cayman has lawyers, accountants and bankers; all the support professionals that would be required.
Charles Bolland: And we have the banking industry as well. We have a great diversity of banks here. That would be a plus for large insurance companies coming down here.
Wayne Cowan: It's very logical.
Charles Bolland: You've got all the necessary infrastructure here, and the capacity for growth.
Ron Sulisz: I think it just needs one company, one to take the first step.
Roger Crombie: One outcome of the various international initiatives appears to be a two-tier system in the offshore world: the solid jurisdictions, such as Cayman and Bermuda, and the others, who will not be able to maintain the highest international standards.
Morag Nicol: I think, at the end of the day, it is becoming clearer to the customer that they can choose a jurisdiction that will give them adequate facilities at reasonable cost, or choose a jurisdiction that gives them the highest of standards and perhaps costs a little bit extra. That, however, is not anything that would concern us in Cayman, because we want to provide a facility that is of the highest standards. We believe that it is those customers who choose the highest standards who are the type of customers that we want to attract to the island, thereby continuing the established degree of excellence, not only in the way we regulate the business, but also by the type of business that we have. This augurs well for the future.
Compiled by Roger Crombie
Roger Crombie is a journalist and chartered accountant who lives in Bermuda. He has written extensively for Global Reinsurance since 1994.