It was a bumper year for some. Jenny Hill reviews developments across the domiciles.
Despite the soft markets, dire warnings of the death of the industry and continuing attack from fiscal authorities, the appetite for captives as a risk financing vehicle seems undiminished. Over 300 new companies were established last year - 78 of them in Europe.Part of this is due to the foresight of the domiciles that have produced new products, such as protected cell companies (PCCs), and implemented new legislation, making the environment for captives appealing despite tightening rules in sponsor origins. Before its publication in November 1998, the Edwards Report into financial supervision in the UK offshore islands was feared by some to be the beginning of the end for these domiciles, but initial responses have been somewhat relieved that most of them have been given a clean bill of health.
Despite innovation, however, there is a continuing need, unaddressed overtly in any domicile, for a cell structure that has a low outlay for small programmes, that is a solution that costs less per cell than a conventional single owner captive.
The role of captives is also changing and we have seen an expansion of the participation they have in their parents' programmes. More are being used as the engine of change within the risk management function, and they are beginning to write combined “enterprise” risk rather than traditional property/casualty. With innovation in the bond markets, special purpose vehicles (SPVs) are also adding to captive numbers.
One would have expected the financial crises in the Far East and Russia to slow the establishment of captives from these areas but this seems not to be the case, with new companies registering in Guernsey and Dublin.
The domicile continues to grow, with 14 new companies last year. The largest single group by far now is of North American origin, within which the largest is direct writers - supporting, perhaps, the theory of Fortress Europe.
European owners continue to dominate; however, an important developing sector is Japanese captive companies. Dublin has seen a rise in interest from the Japanese market, as deregulation begins to bite and as Japanese insurers look to expand overseas with their clients.
Ireland is following a low tax strategy with annual reductions in the rate to 12.5% by 2003. This will make it attractive to some newcomers, but unattractive to the Japanese if their home tax rate does not reduce pro rata, and the attitude of the Japanese tax authorities remains the same.
The domicile will come under increasing competition from Gibraltar, which has all the benefits of membership of the European Economic Area (EEA) and a tax rate that can be set for 25 years.
The number of single owner captives at nine is static, but the number of rent-a-captive accounts is increasing and if cells are counted, as in Guernsey and elsewhere, it doubles the total number of insurance programmes. This is an interesting development for both Gibraltar and the industry. Is the increase in PCCs and rent-a-captives a reaction to the tax authorities' continued attacks on captives or is it simply that the structures lend themselves to today's requirements? They are certainly not a cheap option.
The peninsular is seeing plenty of enquiries from UK and European captive prospects, but the lead time on captives as always is lengthy, and this may be why it has seen limited growth.
Gibraltar has enacted new legislation that reconfirms previous statutes and makes a special case for captives. The government has also implemented refining legislation that will attract the right sort of expertise to the domicile by tax breaks for individuals and tax concessions on office space and other overheads.Target areas are other European countries, Latin America and the United States where there may be a synergy with Spanish speakers.
This is the biggest European domicile and one of the most aggressive in marketing. It is also most active in seeking new ways to differentiate, and is not afraid to break new ground. It is on the net in a user-friendly way with up-to-date information and advice.
During the year the PCC legislation was amended to clarify the position of creditors to an individual cell and the access they might have to core capital. Although every attempt has been made to structure the entity so that the cells are self-sufficient, the fact remains that the core capital remains vulnerable and other cell members could find themselves without a core in certain circumstances. They would, no doubt, be inundated with offers from other cores to attach, but the timing and terms of this attachment would be outside their control. Nevertheless, PCCs have been found to be useful vehicles for single groups and collections of unrelated parties, thereby doubling their appeal.
The rewards of this marketing strategy have been 40 new programmes, including 30 new cells. Significant increases have been from the UK (a slight surprise) and other European countries. Has the captive revolution now taken off at last in mainland Europe?
Isle of Man
The island has seen a static year. The total net number of captives is very much the same, although there have been nine “surrenders”. Funds under management though, at £4.7 billion ($7.5 billion) show a healthy and active market. The island remains heavily dependent on the UK market, although other zones are increasing in importance as technology and telecommunications develop. The number of surrenders at nine is significant, but this is due mainly to merger and acquisition activity, the soft market and insurance premium tax affecting the very small programmes.
Redomiciliation is yet to prove itself to be a net generator of business. Three captives in and two out leaves the position numerically unchanged. Without it, the numbers might be different, but would the island have attracted as much new business? Cell structures have always been allowed, but PCC legislation has not been implemented. Perhaps it was seen as too copycat, but it has proved a successful strategy for Guernsey and several other domiciles are giving it attention.Competition from Guernsey is fierce and the Isle of Man continues to suffer from it. Even Russian owners, once its sole preserve, are now domiciling their captives in Guernsey.
South Africa has been an important source of business for the island, but the conglomerate structure of many South African companies lends itself to the PCC structure. With some of the biggest companies now being traded in London, the attitude to captive ownership and domicile might well change.
Larger captives are becoming more sophisticated, and their programmes include business risk along with the traditional hazard and trading risks.
This is the new boy on the block, but already 14 owners have selected it as the preferred domicile. It has been the first in Europe to attract a securitisation programme from the US using an SPV, and this may be a sign that Jersey has successfully leveraged their banking connections to attract business.The island has marketed itself heavily and professionally, targeting the US and the UK. Guernsey, however, does not yet seem to have felt the competition, but this may be a major threat in years to come.
There is no doubt that Luxembourg is feeling both the heat of competition from more flexible regimes and the backlash of tax authorities in France and other European countries. Having a mandatory reserving policy may not be the best strategy after all, and Luxembourg must now look at ways to make its legislation fit the future demands of owners more accurately.
Moving a captive from Luxembourg is not easy, but neither is paying 39% tax - even when it has been deferred for 10 years. The government is reluctant to part with captives, but we will probably see several in run-off, unless major changes are achieved. Current poor showing in the new captive stakes indicates just how difficult the situation has become. Hopefully the legislation will be changed quickly, and Luxembourg can again take its place as a premier European captive destination.
Malta has enacted legislation that complements the previous act (1981) and raises regulation and supervision in the island to international levels. Of paramount importance in this era of tax focus is the amendment to the Tax Act, dealing with the taxation of insurance companies. It is hoped that this will provide a well regulated, competitive and effective tax environment in which companies can establish and grow.
The island is moving once more towards EU membership and the amendments to the capital requirements and solvency regulations for insurers are modelled on the EU directives.
As before, the initial tax rate is high - to attract business from areas where the taxation authorities require this, but reductions can be obtained through discounts on distributions. This set-up may benefit companies situated in some tax jurisdictions, but Malta may have restricted its market unnecessarily. The situation in Gibraltar is much more simple - a tax rate between 0% and 35% is chosen and implemented for 25 years. The latter gives certainty, which is important to many companies, though on the other hand it might be argued that Malta gives the opportunity for flexibility in the future.
Just to be on the safe side, Malta has also made provision for the minister to make regulations that allow PCCs and redomiciliation into and out of the island. As in other jurisdictions, the companies that will manage the future captives will also enjoy special tax benefits.
Another relative newcomer and another success story. In the declining market, Switzerland has attracted a further two captives (although the Tillinghast Captive Insurance Directory lists 23, Swiss officials claim only 17 which is interesting).
Zurich is marketing most aggressively in the captive arena. Zug offers similar benefits in terms of tax, but Zurich is the recognised centre for financial expertise, and some global companies are centering their treasury and financial risks there. It is natural for the captive to be included in these calculations.
Unfortunately the trend is towards direct writing captives, and as Swiss legislatory benefits are for reinsurance companies only, the market will be limited by this. Even if direct writing were allowed, Switzerland is not party to the EEA Agreement and companies domiciled there would not be allowed to underwrite directly into partner EEA states. Redomiciliation legislation has not been implemented, making it more difficult for companies to plan for the future.
Arguably the most exciting and innovative development in the captive industry in the past 12 months has been the emergence of Lloyd's as a captive domicile. The past year saw intense activity in writing the new legislation and having it approved by the Council of Lloyd's.
Success arrived on 1 January 1999 with the first registration, though future appeal may be limited. A Lloyd's captive is not for all. The profile of the preferred customer is a company with a large premium spend and worldwide business interests. Minimum retained premium should be in the region of $15 million and capital requirements are high compared with other domiciles, so it is really only these very big companies, with global needs, that will benefit from being at Lloyd's. The franchise, which allows direct writing into 67 different countries, will enable global companies to direct and drive their own destinies, retaining significant risk and accessing the complete range of reinsurance options available.
Statistics on other captives in the UK are sparse. They have no special treatment under any legislation and are not, therefore, registered separately from other insurance companies regulated under the Companies Act.
The significant developments for parents wishing to domicile in Europe have undoubtedly been the PCC structure and captives at Lloyd's. Other domiciles' changing legislation has been largely catching up or defensive strategies.
Owners' needs are changing too - from a requirement for profit sharing on the property/casualty programmes, to a focus for combining financial and hazard risk.Net gains in numbers of captives and the increase of funds under management show that the captive industry is on the increase despite negative macro economic and sector developments.
Jenny Hill is an associate with Willis Risk Solutions. Tel: +44 (0) 171 488 8866; fax: +44 (0) 171 488 8968; e-mail: email@example.com. Her sources are official published statistics, the Tillinghast Captive Insurance Company Directory and original research.