Despite the soft insurance market of the last few years, having a captive insurer has not lost any attractions. Most of the major multinational groups (those belonging to the United States Fortune 500 and the United Kingdom FTSE 100) have established, or supported, their captives during a period when captives may not have seemed too necessary to external observers. Insurance groups too have shown an eagerness to form captives, often as a result of mergers and acquisitions which have made group captives an attractive option in terms of retaining premium rather than reinsuring.
Although worldwide, the pace of new formations slackened last year, according to Tillinghast- Towers Perrin's Captive Insurance Company Reports (CICR), there were significant increases in the financial size of existing captive companies. In March, CICR reported a 55% growth in total captive market premium in the last two years compared to a gain of around 6% in numbers, while the number of captives grew by 250 in 1999. However, 156 licences were removed, leaving a net gain of 94, well below 1998's net gain of 151.
Competition is strong between those countries that have established facilities and regimes expressly to attract these captives. While Bermuda and the Cayman Islands lead the way, collectively Europe is the third-largest worldwide captive domicile, with Guernsey, Luxembourg, Isle of Man and Ireland, currently the leading venues. These are all subject to scrutiny not only from the OECD (in terms of unfair tax concessions) but also from the European Union with its basic premise of ensuring a level playing field. Table 1 shows the number of captives in European and Asian domiciles according to regulatory sources, as well as the number found in Best's Captive Directory database as at the end of 1999.
The smaller European captive domiciles are developing at a faster rate than the more established ones in terms of attracting new registrations, according to statistics compiled by European Insurance Management Services (EIMS). Speaking at an IBC European captives convention in London earlier this year, EIMS general manager, Chris Johnson, said that the figures were “not a prodigious result for the domiciles as a whole.”
Mr Johnson said that many European territories have swingeing premium taxes - for example, 22% in Italy, while the UK's rate is gradually creeping up with each government budget. “There comes a point where the savings in cost of risk gained by establishing a captive will be eroded by these unrecoverable taxes to such an extent that it makes more sense for the parent simply to fund the losses itself. This is particularly true for what I call ‘noise level' losses, where it is simply a question of churning money to fund predictable losses. It begins to make more sense to establish a ‘virtual captive', which is simply a formally run large deductible!”
He added that many companies were looking at more innovative uses for their captives and, with more and more diversification and innovation in the captive field (in its widest sense), the pure captive manager would become a dying breed, being replaced by firms with a wide range of professional understanding or the ability to assume new concepts which go beyond what could be called the traditional insurance viewpoint.
However, companies currently appear to be selecting their captive managers using traditional criteria. A recent survey by Aon Insurance Managers - Captive Management Research Project 1999 - found that the most popular selection option when choosing a captive manager was based on historical connection and long term relationship. Most captive owners also stick with their choice; 82% of the 100 respondents have continued with the same manager since establishing their captives.
The survey showed that less than half the captive managers offer underwriting and claims analysis while only 8% provide loss control (see Table 3).
Despite the slackening in new formations in 1999, managers report strong interest - much coming from non-traditional sources. For example, Cullum Beaton, managing director, SINSER (Guernsey) Ltd sees tremendous opportunities for captive insurance growth coming from the Far East, so much so that SINSER is opening an office in Tokyo this month to service its Far Eastern clients. “The level of interest from the Far East is immense. In fact, globally, interest in risk management and captives is higher now than it has ever been. This was evident at the recent US Risk and Insurance Managers (RIMS) conference, where there was a significant proportion of non-US attendees.”
Don Lawson, director of IRM (Guernsey) Ltd shares this view: “A fair number of Guernsey's captives do not have UK parents. Less than 50% is UK-owned. We envisage a continuing number of enquiries from those parts of the world, like Asia, where captives are still a fairly new concept.”
David Finch, ERC Management, Dublin, says that, since most of the largest companies, particularly in the American market, already have established captives, the main growth now is coming from the next tier down from the Fortune 500 or even 1,000 companies.
“We are also seeing some of the bigger groups regionalising to some extent. For example, you might find a US group which is international with a captive in Bermuda setting up another in Dublin for its European subsidiary.”
If the profiles of the new captive owners are changing, so also are the purposes for which captives are being formed.
There is a continuing erosion of “unfair” tax concessions in respect of captives. Contributory moves include: the introduction of controlled foreign company (CFC) law, the continuing UK clamp down on designer rate tax regimes, and proposed EU regulations to counter harmful tax practices (scheduled for introduction in 2003 if member governments give the necessary support). With tax benefits fast disappearing from the frame, would-be captive owners are focusing on the other advantages that captives can bring. Managers within those domiciles affected by CFC say that they do not believe that it will affect their ability to compete.
The Edwards review
Recently, the UK's offshore centres in the Channel Islands came under scrutiny with the Review of Financial Regulation in the Crown Dependencies, commissioned by the Home Secretary and prepared by Andrew Edwards in co-operation with the island authorities. Commissioned in January 1998, the review looked at the international finance centres of Jersey, Guernsey and the Isle of Man, their regulation, pursuit of financial crime and co-operation with other jurisdictions. While perhaps initially viewed with some trepidation, Mr Edwards' report in the event has provided a fair amount of marketing ammunition for the islands in that it concluded that they were properly regulated.
Among other things, Mr Edwards said that the islands' success has depended importantly on internal self-government, which has enabled them, like other offshore centres, to offer customers tax and other advantages that the large centres cannot readily emulate and that, compared with other offshore centres, they have developed reputations for stability, integrity, professionalism, competence and good regulation.
“The professional people I consulted mostly put the islands in the top division of offshore centres. Many of them commended their standards of regulation, the absence of corruption and their co-operation with other jurisdictions, especially in the pursuit of drug-trafficking.
Some raised concerns as well. The main concerns related to conflicts of interest, customer disputes, and the activities of certain companies, company directors and professional firms in the islands. There were fears that island activities were facilitating tax evasion and other forms of financial crime. Officials outside the islands, while mostly complimentary, felt that the authorities could sometimes have co-operated better in the pursuit of crime.
“Similar concerns would, I suspect, have been raised about any other finance centre,” Edwards reported.
The islands scored highly on political stability and have “impressive” arsenals of financial, company and criminal legislation, mostly similar to, but not identical with, UK statute law. The common law systems resemble English common law, precedents from which are considered persuasive.
Mr Edwards did not, however, tackle the thorny question of tax regimes. Although he mentioned that offshore centres generally are sometimes criticised for maintaining tax regimes that induce businesses to desert onshore jurisdictions and deprive them of tax revenues, he confirmed that these issues lay outside the scope of his report.
On the subject of protected cell companies (PCC), Mr Edwards pointed out that there is no knowing whether they would survive legal challenge in courts outside Guernsey. However, he said that the Guernsey supervisors have rightly been scrupulous in highlighting this uncertainty, and that they should ensure that firms offering the facility are similarly scrupulous.