Captive domiciles continue to develop despite the background of a soft insurance market and pressure from tax authorities, comments Alison Craig.
In what is a discretely but strongly competitive market for new captives, the Gibraltar government and captive managers have taken a brave decision with their second annual conference being held on 25 and 26 November.1 They have invited insurance regulators from some of their natural rivals, the Isle of Man and Luxembourg to speak among others on which captive domicile multinationals should choose for European exposures. Representatives from other offshore insurance centres, including Bermuda, Dublin and Guernsey, feature elsewhere in the programme.
Gibraltar got a boost this summer when HSBC Insurance Management joined forces with long established Gibraltar captive managers Norwich Union to give clients access to the Gibraltar market. HSBC has offices in Bermuda, the Cayman Island, Cyprus and Guernsey from which it says it manages about 100 captives. When the deal was announced HSBC Insurance Management chief executive Peter Walker said: "Gibraltar has the potential to become an important new location for captive insurance companies and we need to be represented there."
Gibraltar's official captive tally has remained at 10 so far this year, despite this acknowledged potential as a domicile thanks to its membership of the European Union and approval last year of its insurance regulatory regime. However, insurance supervisor Jim Costin reports that certain Gibraltar insurers are taking advantage of the single licence to do business into the European community.
In the soft market, the more established domiciles are continuing to attract new captives but growth looks to be slower than in the previous year. Guernsey saw 13 new captives formed in the first seven months of 1998, taking the total registered to 347. The Isle of Man reports seven new formations during the first half of 1998 compared to 11 during the same period of 1997.
The IoM's redomiciliation legislation is continuing to attract some captives. Three relocated to the island in 1997 and two more have been added so far this year. One of these was the first transfer of business to the IoM from the Cayman Islands.
Guernsey has benefited from its protected cell legislation which was introduced last year and which has since been amended to increase its robustness to any legal challenge from outside the island. A further four protected cell companies have been set up this year. There are now 23 such companies in Guernsey, nine of which carry out various kinds of insurance business.
One of the most recent insurance protected cell companies (PCCs) is Harlequin Insurance PCC, a joint venture between Polygon, a long established Guernsey insurance company, and London market broker and corporate investor, the Benfield and Rea group. The UK insurer Guardian Royal Exchange has set up Guardian Insurance (Guernsey) PCC which will be marketed under the name SpectraCel.
Three PCCs offer rent-a-captive facilities to smaller companies and organisations for whom the cost of setting up their own captive would be too expensive. They are Portway Insurance PCC, White Rock Insurance Company PCC and Bailiwick Insurance PCC. City and Provincial Insurance PCC has three cells holding similar insurance operations on behalf of three separate companies.
Guernsey has this year enacted a law under which all insurance intermediaries come under the statutory supervision of the Financial Services Commission (FSC) by the end of the year. This follows a lengthy period of consultation between the island's FSC and representatives of the local industry. Director of insurance Steve Butterworth sees the new law as continuing the island's reputation for "firm, fair and flexible supervision".
It has been a quiet year for captive formations in Jersey with two new companies registered. More significant has been the establishment on the island of the Jersey Financial Services Commission, an independent statutory body corporate that has assumed responsibility for the regulation, supervision, development and promotion of Jersey's expanding financial services industry. Although ultimately responsible to the States of Jersey, the island's legislature, the new commission will be self-funding and will have discretion how it uses its resources to meet the demands of the finance industry. The chairman of the commission is Senator Frank Walker, who is also president of the island's Finance and Economics Committee.
Even in the largest captive domicile, there are slight signs of a slowing of new captive business. Total new company formations in Bermuda remained unchanged at 53 in the year to 31 August 1998, compared to the same period of 1997. This includes 10 new single owner captives, the same as last year, although there were only 10 new class two captives against 16 in the first eight months of 1997. Class 2 companies include multi-owner captives or those whose business comes from more mixed sources,. However, there were 23 new class 3 companies (1997 - 20) some of whom may be larger captives or those writing substantial amounts of third party business. (See table - Bermuda).
Despite the current comparatively slow increase in new captives, there is clearly belief that undeveloped markets hold real growth potential. In Europe, the newest domicile is Malta which this summer passed two new insurance laws which became effective on 1 October. Although Malta is not a member of the EU, the purpose of the legislation is to raise Maltese regulatory standards to an international level and incorporate a number of relevant European insurance directives.
Amendments to the provisions of Malta's Income Tax Act dealing with the taxation of insurance companies are an essential element of the new legislation. These changes are intended to create a competitive and effective tax environment for insurance and reinsurance companies, including captives.
Consolidation among the world's broking companies has had a significant, though less publicised, impact on captive management because many of the largest captive managers are subsidiaries of broking companies. Although estimating precise numbers of captives varies with definition and the quality of information from the domicile, Tillinghast's Captive Insurance Company Directory and Report (CICR) are widely regarded as authoritative, independent sources. A study done by CICR in 1995 ranked six broking company subsidiaries among the 10 largest captive managers; three years later the number had fallen to four of 10 with the merger between Johnson & Higgins and Marsh & McLennan and Alexander & Alexander and Aon.
Updating the study this year, CICR shows J&H Marsh & McLennan as the largest captive manager with 717 clients. The takeover of sixth ranked Sedgwick will bring the total to 878, compared to Aon's 401, both based on start of the year figures. Thus, J&H Marsh & McLennan will be more than double the size of its nearest rival Aon in the number of clients with captives under management. The largest independent is European based Sinser, which has risen from number six to three in the rankings.
One approach domiciles have adopted is wooing virgin territories as far as captives are concerned, and at the moment Latin America is the princess whose hand the domiciles and their managers seek. In August, for example, the managing director of the Cayman Island Monetary Commission, Neville Grant, visited Brazil, Argentina, Uruguay and Chile both to discuss regulatory procedures with fellow supervisors and to brief financial services organisations on what Cayman has to offer. Tillinghast's CICR has this year listed a trickle of new captive formations from sponsors in Latin America and Japan.
Although it is impossible to produce figures, a likely response to the soft insurance market is for owners to buy more commercial insurance and reduce the amount flowing through their captives. They may also look for extended ways of using their captives, often through business for employees or customers, although it does cause some anxiety among regulators. For example, a Fortune 500 company is reported to have developed a personal lines insurance programme for its employees through a payroll deduction plan which it is running through its existing multiline captive. In Norway, a captive insurer owned by Norsk Energiverk was reported to be planning to launch a special policy to protect hydroelectric power companies from losses due to drought.
Tax and regulation
Supporters of captives usually play down the importance of tax issues, but they cannot be ignored. In France, the tax authorities - long suspicious of captives - this April issued instructions that claims reserves in foreign captives owned by French companies would be treated as though they were established in France.
According to the French authorities: "The technical provisions used to determine the taxable result of reinsurance captives will be deductible as they would be under French law. That is to say they will be treated as though the foreign company were taxable in France."
The policy is aimed particularly at reinsurance captives in Luxembourg, where equalisation reserves are required by local law. Dublin, however, home to a number of French owned captives is less concerned because of its dual taxation treaty with France.
In Dublin the tax news is good. The single largest question hanging over the development of captives in the International Financial Services Centre (IFSC), that of the future tax rate, was resolved this summer when the Irish government reached agreement with the EU Commission to phase in a 12.5% general rate of corporation tax for trading activities by 1 January 2003. However, companies in the IFSC will continue to enjoy a concessionary rate of 10% until the end of 2005. The necessary legislative amendments to provide for the new corporation tax regime will be included in next year's finance bill. (See box on page 51.)
The change will require average reductions in the standard rate of corporation tax on trading income of 4% per annum over the next five years. While the cost of these reductions should be partly offset by buoyancy factors, the Irish government said that it would need to look very closely at all existing business tax reliefs and the continued rationale for some or all of them. The government will also examine the scope for revenue raising measures aimed at supplementing the yield from commercial tax payers to ensure that the business sector continues to contribute what it describes as "an appropriate share of overall tax revenue".
Alison Craig is a freelance insurance writer.
1. The conference is being organised by Risk and Insurance Research Group and Norwich Union (Gibraltar) in Gibraltar.