In its annual survey of European captives, Global Reinsurance polled captive management companies in all major European domiciles on the changes they have seen in 2001 compared to 2000, and their views on prospects for the future.

Captives appear to be a re/insurance fashion which rarely dates. There are some die-hards in the industry who continue to assert that captive re/insurers are a form of alternative risk transfer - though the four decades or so of the captive industry's existence could be deemed as sufficient to make the concept fairly mainstream, particularly when there are around 4,500 captives operating nowadays. In fact, captives are probably more of a `classic' item in the risk transfer wardrobe than a fashion statement that is aired some seasons, then put in the closet until the next time its cut is back in vogue.

This contention is easily supported by the continued increase in captives in recent years, when the traditional market was, in some cases, hosting a rummage sale of capacity. In the depths of the soft market, the growth in both use and pure numbers of captives slowed, but rarely did the market show a backwards slip. In fact, in many cases where numbers diminished this was as a result of captive parents merging - or in some cases ceasing to trade - rather than a board-level decision to turn wholly to the traditional re/insurance market. Figures released earlier this year by rating agency AM Best for 2000 show captive numbers internationally up just over 2% compared to 1999, while numbers for the four largest European domiciles increased just over 1%. These figures are somewhat deceptive; for the same period, net premiums written, as reported to each European domicile's regulator, increased an average of 14.8% compared to 1999, in spite of the Isle of Man showing no change year on year.

New formation trend
A number of captive managers were reporting a continued trend towards new formations in the middle of 2001, when the re/insurance market was only just beginning to come out of the depths of the soft market. Captive managers and domicile regulators alike were at pains to point out that these were not `opportunistic' formations, being incorporated to anticipate any prospective hardening in the market conditions. Indeed, certain regulators commented at the time that any proposed captive which did not have a sound business plan may be turned down for a license. Nevertheless, when the dramatic hardening took place towards the end of the year, those parent companies with established captive operations in place were able to take advantage of their presence to manage new exclusions from conventional programmes, as well as the soaring deductibles which were so much a feature of the January 2002 renewals.

A report issued by AM Best in April this year, looking at the top 12 captive domiciles around the world, recognised the increased volume of business through captives in the latter half of last year. "The environment already was conducive to growth of the alternative market in the first half of 2001 through self-insurance, captives and capital market solutions as commercial insurance rates continued to increase and capacity continued to shrink," it stated. "The tragic events of September 11 and the resulting uncertainty created in both the reinsurance and commercial insurance markets have only accelerated the migration as risk managers and their advisers react to a situation forced upon them."

It continued: "Growth is expected to continue as risk managers make better use of their existing captives and form new captives to handle pricing, coverage and capacity disruptions caused by the commercial insurance market. Multi-owner captives will see steady growth in membership as will segregated cell companies, particularly from middle market companies that are heavily affected by a hardening market."

Looking specifically at the European sector, there is still a limited offering for segregated cell companies, also known as protected cell captives. Until recently, only Guernsey had legislation in place to offer such facilities - in fact, in 1997 it was the first domicile in the world to pass PCC legislation. But because of its Channel Islands status, it does not fall under European Commission regulations. By contrast, Gibraltar has European Union membership through the UK, and in 2001 introduced its Protected Cell Companies Ordinance. PCCs have been established on `the Rock', as Gibraltar is known colloquially, since 1997, but the launch in late Spring this year of White Rock Insurance Co (Gibraltar) PCC Ltd by Aon Insurance Managers (AIM) was the first real evidence of segregated cell companies moving forward. At the time, Philip Stamp, CEO of AIM, noted that cover had been withdrawn from certain parts of the market, creating capacity problems for buyers. "One particular problem seems to be the withdrawal of capacity from what have previously been seen as `fronting markets', providing access to the true risk carriers," he said. He foresaw the new organisation being able to provide this type of facility, enabling medium-sized companies to set up individual cells within captives, and writing insurance programmes across all European Union member states. AIM already had a Guernsey-based PCC company, White Rock Insurance Co PCC Ltd, prior to launching the Gibraltar operation, which was formed on AIM's purchase of local captive management company EIMS.

Worldwide figures on captives in 2001 gathered by AM Best indicate that numbers were up on the year. According to Best's, 2001 saw the largest number of net formations since the rating agency started collating the figures a decade ago. Out of a net gain of 114 captives worldwide, 316 new captives were licensed and 202 were liquidated. However, growth appeared stronger in the well-established captive domiciles; Bermuda registered 91 new captives; Cayman registered 49; Vermont registered 38; and the British Virgin Islands registered 33. It is only at this point that a European domicile appears in the list, as Guernsey reported an increase in captive numbers of 33 over the course of 2001. In 2000, it appeared fourth in the list of numbers of new captives, above BVI. Hawaii and Ireland both slotted in after Guernsey with 15 new captives apiece. Of the total 4,521 active captives operating in 2001, 1,230 - 27% - have European parent companies, according to the Best figures.

The pace of growth is unlikely to slow, according to Best's report. "Traditionally, captive growth has accelerated during hard property/casualty markets, as underwriting capacity and coverage availability diminished," it stated. "AM Best believes that, despite rising leverage, the captive industry will remain well-capitalised and well-positioned for the influx of new business. As operations expand into new risk exposures and unreasonable business, emphasis is on the prudent use of capital, as well as risk adjusted operating returns."

Survey results
This is the first time Global Reinsurance has separately reported the views of captive managers in European-based domiciles. In spite of the slower growth in European jurisdictions, the fact that more than a quarter of the world's captives have European-based parents - most of whom are operating captives out of European jurisdictions - means this is a significant market, and one set to grow under current conditions.

Questionnaires were sent out to all captive managers in European domiciles including: Guernsey, Jersey, the Isle of Man, Ireland (Dublin), Gibraltar, UK, Luxembourg, Switzerland, France, Norway, Denmark, the Netherlands and Sweden. Although the captive management companies responding to the questionnaire are identified to Global Reinsurance, all results are reported anonymously.

Firstly, Global Reinsurance asked how many people were employed within the management company in each domicile. Of the survey respondents, the same proportion - 28% - employed either less than five people or more than 25. Of the companies employing more than 25, numbers of staff ranged from 29 to 65 (see chart 5 on p38). Unsurprisingly, the larger the company, the greater the number of captives managed and the wider the range of other services offered by the organisation. These services include:

  • actuarial consulting;

  • pensions administration;

  • trust company management;

  • captive feasibility studies;

  • captive formation;

  • accounting;

  • government reporting;

  • claims processing;

  • claims reserve analysis;

  • online access to claims data;

  • loss forecasting;

  • association captive management;

  • underwriting for captives;

  • rent-a-captive management;

  • counter-guarantees;

  • export credit insurance;

  • reinsurance services including financial reinsurance;

  • run-off company management;

  • offshore company management;

  • fiduciary services;

  • virtual captive management;

  • incubator services;

  • rent-a-risk manager services;

  • risk financing consulting;

  • taxation services;

  • reinsurance broking services;

  • treasury and finance services;

  • securitisation services; and

  • outsourcing services.

    The response to the question of the number of captives managed in 2001 compared to the number managed in 2000 produced an astounding 35.7% increase (see chart 3 above). This is, however, mainly a reflection of mergers and acquisitions activity within the captive management sector itself; during the course of the year, AIM bought SINSER, a Sweden-based captive management company which had more than 220 captives under management before the purchase. Nevertheless, captive managers also attributed growth in numbers to:

  • new business;

  • increased demand for captive solutions;

  • niche products being written;

  • underwriting agents setting up their own capacity;

  • the hardening of the insurance market;

  • transfer from competitors;

  • the restriction in traditional cover; and

  • continuity of coverage.

    Only three managers reported a drop in numbers of captives under management, put down in one case to an insurance license being surrendered.

    Totalling the direct captives under management compared to the reinsurance captives under management in 2001, surprisingly there was almost 25% more direct captives noted in the survey, possibly because of a skew in the respondents (see chart 1 on p36).

    Comparing the status of active captives under management in 2001 with those under management in 2000, most companies noted an increase in numbers, some substantially, though again this is likely to be a result of M&A on the captive manager's part. Taking the M&A skew out of the figures, half the captive management companies surveyed reported an increase in active captives in 2001 compared to 2000, though the increase in numbers was confined to single digit growth. Reasons for the growth in the number of active captives included increased demand in general, and a growing interest in PCC mechanisms.

    Inactive captives lived somewhat down to their name: only two captive managers which responded to the survey noted increases in inactive captive numbers, while one noted that one of its inactive captives had shut completely during 2001. The vast majority of respondents had no inactive captives under management in either 2000 or 2001 (see chart 2 on p37). It would appear that the affects of M&A activity at parent company level do not include a trail of captives in run-off across Europe.

    Captives domiciled in European locations have parent companies predominantly located in Europe but also a number headquartered elsewhere in the world, using the domiciles for the European part of their international operations. Parent company locations included:

  • Netherlands;

  • France;

  • UK;

  • Italy;

  • Germany;

  • Norway;

  • Sweden;

  • Spain;

  • Belgium;

  • Luxembourg;

  • Ireland;

  • Denmark;

  • Finland;

  • Austria;

  • US;

  • Japan;

  • Russia;

  • South Africa; and

  • Panama.

    Again, captive manager M&A has skewed the results of the questions asking about premium volumes year-on-year, in particular for 2000 and 2001 where premium volumes for direct business appear to have increased almost 64%. More realistic is the expected increase in volumes for 2002 compared to 2001, where growth is anticipated to reach 11.8% on the direct insurance side and about 6% on the reinsurance side.

    Reasons for changes in premium volumes in 2002 compared to 2001 included:

  • increased participation of existing captives in group arrangements;

  • new formations;

  • significant rate increases;

  • increased demand for employee benefits business;

  • marketing of niche products;

  • previously dormant captives restarting writing;

  • increased use of captives to write excesses on policies;

  • expansion of business within captives; and

  • new insurance programmes.

    Nevertheless, some captive managers that possible top line growth may be tempered by merger activity, as well as certain businesses ceasing.

    In general, the questionnaire respondents appeared fairly traditional when it came to the types of business currently being put through the captives under their management (see chart 4 on p37). More than a third of the business through the captives is property - 38% of all business when averaged out over all respondents. Liability/casualty business comes in a close second at 33%, while `other' business took the third slot. This category included credit insurance, employee benefits, mortgage indemnity business and extended warranty. Life, a class that has been slowly on the increase over recent years in European-located captives, accounted for the remaining 11% of premiums, a fair proportion of the growth due to an increase in certain lines of employee benefits.

    Reasons cited for the increase in certain lines included:

  • property retentions increasing due to cost and availability of cover in the traditional market;

  • `other' classes increasing because of the interest in structured financial solutions products using PCCs;

  • increases in employee benefits packages;

  • increasing use of captives to write liability lines as capacity becomes difficult to find in the traditional market; and

  • higher rates and retentions across all classes of business.

    Few of the captive managers which responded to the questionnaire were reticent about saying which domiciles they perceived as the direct competition to their own, though views differed within domiciles. For example, different Guernsey-based captive managers separately cited the Isle of Man, Dublin and Luxembourg as their greatest competition. The Isle of Man, said one Guernsey manager, provided a large offshore life centre with good staff availability, while Dublin could offer clients EU access. Another, however, commented that Guernsey has "unique characteristics from other domiciles".

    Dublin-based captive managers also varied in their opinions of where the domicile competition was coming from. For one captive management company, Luxembourg was seen as the greatest competition, primarily because of its location to the Netherlands, (an important client base for the Dublin-based company), as well as sharing Dublin's characteristics of being within the EU and the Eurozone. Another cited Gibraltar as a competitor to be watched for that very reason, although it was noted that it is not as developed as Dublin. That particular captive manager also pointed out that there were "no others as direct competitors for insurers". Another Dublin-based captive manager cited Luxembourg as the strongest competition, most likely because of its tax treatment of catastrophe reserves, while another saw Guernsey as "challenging in Europe", and Bermuda as "challenging from the rest of the world".

    The Isle of Man-based captive management companies which responded to the survey all named Guernsey as direct competition from a domicile point of view. One pointed out that Guernsey had "similar offerings in the same time zone and catchment areas," while another cited Guernsey's PCC legislation. Gibraltar-based captive managers saw Dublin as the major competition, most likely because of the EU access both domiciles enjoy.

    When asked what were the most important reasons for clients to establish in their particular domiciles, the captive managers came up with a variety of reason. Domicile-by-domicile, these included:

    Guernsey:

  • strength and depth of experience, over 25 years;

  • reputation as a well-regulated insurance centre;

  • convenience to London and UK parents;

  • offshore, British and controlled;

  • firm but flexible regulation; and

  • solid infrastructure.

    Isle of Man:

  • well-regulated jurisdiction;

  • professional infrastructure;

  • proven track record for quality;

  • accessibility of insurance and pensions authority;

  • tax-efficient for certain companies;

  • time zone and ease of communication;

  • stability of government and OECD acceptance; and

  • proximity to the UK and Europe.

    Dublin:

  • 12.5% corporate tax rate from January 2003;

  • within the EU and Eurozone;

  • respected regulatory and accounting practices;

  • proven infrastructure;

  • proven track record of financial/insurance expertise;

  • direct writing capability; and

  • recognised as challenging or leading captive activity domicile in Europe.

    Gibraltar:

  • range of structures allowed including PCCs, rent-a-captives, direct, reinsurance and third party;

  • written direct using freedom of services (across Europe); and

  • low tax regime.

    Sweden:

  • good reserving; and

  • corporate contributions allowed.

    Denmark:

  • low capital requirements; and

  • (perhaps the most pragmatic answer) "Denmark not a bad domicile."

    Finally, Global Reinsurance asked the captive managers what affect the shape and attitude of the parent companies has had on the captive management business. At parent company level, mergers and acquisitions activity "has created more business for us, overall," commented one captive manager.

    Another, however, had a less enjoyable experience. "We have and continue to be affected by this. As a result of M&A activity, parent companies inevitably do not wish to maintain multicaptives." Some respondents noted that the numbers of captives under management had reduced recently, though one added it was "part of the normal commercial landscape". Others saw M&A in a more positive light. It had "increased opportunities and demonstrated the solutions captives can offer," commented one respondent.

    Inevitably, parent companies are changing the use of their captives to reflect the changes in the marketplace. "In an increasingly hard market, retention levels are similarly increasing," commented one respondent. `

    Others said parent companies were adding lines and adding capital, as well as using their captives to provide terrorism solutions. Others again noted that parent companies were "retaining more risk," using their captive as a "vehicle to demonstrate sound risk management" and to access the reinsurance markets. Other parents are using their captives to write more third party business, presumably taking advantage of the current market conditions, while others again are using their captives as a fronting mechanism in the EU. One captive manager noted that parent companies are "moving from a more traditional passive use to a more active sophisticated financial and risk management" model.

    Overall, the evolution of the European captive industry looks set fair. One survey respondent predicted, "2002 and 2003 should see steady growth in the captive industry" and developments such as the growing interest in PCC facilities are helping to maintain the course. With a number of licenses in the pipeline in several jurisdictions, the classic captive remains in fashion.

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