Seeking a spectrum of views on issues affecting insurance in the Cayman Islands, Global Reinsurance invited electronic responses from insurance executives and the regulator. Their responses were merged and a second round of updated responses collected. The results present an informal but informative analysis of industry issues today.

Roger Crombie: Tell us about yourself and your work.

Gordon Rowell: I have been Head of Insurance at the Cayman Islands Monetary Authority since January 2001. I always wonder why such great emphasis is placed on the role of the Superintendent of Insurance, when the entire department works hard in the background to maintain a strong regulatory unit. The Insurance Division in the Cayman Islands is particularly strong and any member of the team can make consistent decisions. Specifically, we do this through practical policy and law changes and balance this by constantly examining ways of providing an environment that potential captive companies would find attractive. This is performed in close consultation with the private sector.

Linda Haddleton: My position is assistant director and manager of the Insurance Department of HSBC Financial Services (Cayman) Ltd. We are the largest insurance management company in Cayman that is independent of a broker network. Traditionally, our new business has come from referrals from existing clients and their consultants. We have been in the business in Cayman since before it was regulated, and we still have many clients from those days. We pride ourselves on our high quality of service, we believe we add value to our clients with our experience and expertise, but we remain reasonably priced, because we prefer to build a long-term, mutually beneficial relationship.

Charles Bolland: I am a partner at PricewaterhouseCoopers in the Cayman Islands (PwC Cayman). PwC Cayman is a member firm of the global PricewaterhouseCoopers organisation of firms. I am a dedicated insurance partner within PwC Cayman's audit and business advisory services department. Together with my fellow partner, Paul Anderton, I am responsible for the provision of audit services to more than 70 offshore insurance companies domiciled in the Cayman Islands. Our aim is to provide the highest quality audit service in the Cayman Islands.

Wayne Cowan: I am one of five partners – with John English in London, Paul Bailie in Bermuda, George McGhie in Singapore and Nick Wild in Guernsey – who form the JLT Risk Solutions captive team. The Cayman Islands company was incorporated in January of this year. Our overriding objective is to provide the highest standards of service to our clients with a distinct ‘hands on' approach in the attainment of client goals. Our size and depth of skills provide us with a great deal of flexibility to develop innovative solutions for our clients.

Roger Crombie: Cayman continues to grow its captive market. What is fuelling that growth and where is it coming from?

Gordon Rowell: Certainly, Cayman's captive market is in expansion. The most common theme underlying captive formation so far has been hardening markets. A closer examination shows that 38 percent of the growth has been from the US healthcare sector, arising from the withdrawal of coverage and severe rate hikes. Even long-standing relationships between the insured and insurer are unravelling. The long-term care industry has been hit particularly hard with the firming market. With the Cayman Islands' local captive management expertise in the area of healthcare, strong, structured captive solutions are emerging.

Other formations have arisen, principally, from tightening in workers' compensation and property rates. The types of organisations that form captives are well diversified. Industries range from hospital systems, finance, retail, and automotive to heavy industrial, chemical and public utilities.

Linda Haddleton: Part of it is a wider acceptance by the broker network that there is an alternative risk transfer (ART) market, and some bypassing to the ART market by buyers. At the end of the day, the answer is more sophisticated buyers in a traditionally slow-moving industry.

Charles Bolland: Cayman is seeing growth across the board, from agency captives to traditional single parent captives being set up by large multinational companies. Some previously dormant captives are being reactivated. Before September 11, as Gordon says, this growth was being fuelled largely part by the hardening of the market in the US. In addition, the events of September 11 have lead to actual or perceived capacity constraints which in turn have resulted in already-planned captive formations being fast-tracked and new interest from firms that had previously not ventured into the alternative risk transfer market.

Wayne Cowan: The vast majority of our business is coming from the US, fuelled by a hardening market and a growing realisation and understanding amongst smaller and mid-sized businesses that alternative risk financing vehicles must be considered when looking at their overall insurance programme. There are still an awful lot of companies in the US that have yet to move down the captive path, one that would be most beneficial to many of them.

Roger Crombie: Are captives being put to wider uses? Are they being seen as facilities for more sophisticated risk financing?

Charles Bolland: One trend we are aware of is increased emphasis on estate planning, where the captive is insuring risks of private US companies and the ownership structure of the captive is designed as part of wider plans to minimise inheritance/estate tax.

Linda Haddleton: Captives are definitely being put to broader uses. The catastrophe bond captives should only be the start. When creative financiers become involved in our industry, the scope is unlimited.

Wayne Cowan: The good old days of the simple single parent captive, writing one line of business with its front and reinsurer assuming most of the risk, are disappearing fast. Clients now are expecting innovative solutions and we spend a great deal of time with potential clients getting the right vehicle in place that will serve their objectives. Very seldom now do we see two clients with exactly similar requirements or goals – this is the real challenge for captive managers and it makes our job very interesting.

Roger Crombie: Most of the early cat bond ventures were based in Cayman. How is that market developing and can we expect other risks to be treated in this way?

Linda Haddleton: The market is developing. Some of the deals take a long time to come to fruition. As (mostly) private placements, not all the activity is publicly known. Some of the deals, by their structure, do not actually require insurers' licences. Others are better structured as insurance deals. Cayman sees a huge amount of this business, only some of which requires insurers' licences. What we have seen to date was very much ‘testing the water'. There is huge scope for creativity, and for structuring arrangements whereby the buyer can optimise by switching from the reinsurance market to the capital markets. We are very interested in working on these deals.

Gordon Rowell: We have seen slow but steady growth in this area over the last four years. Two alternative financing vehicles have formed in 2001, but not as traditional cat bond issues. In essence, the type of risk being packaged is now even more complex and involves removing credit risk from an organisation's balance sheet.

Charles Bolland: Our view is that cat bond deals will see significant growth following the events of September 11. This is derived from the assumption that reinsurance rates will go up significantly and that there may be reduced capacity for certain types of risk. It is probably too early to say what will transpire but, given its track record in such deals, Cayman is certainly well placed to take advantage of growth in this area.

It is worth noting that these deals do not necessarily need to be structured as ‘insurance' deals – i.e. depending on the structure of the deal, the Cayman special purpose vehicle that issues the notes into the capital markets may not need to be a licensed insurance company. Cayman has a long and successful history as a domicile for structured capital market transactions and it may be that growth in these types of vehicles is not fully reflected in the statistics of the Insurance Department of the Cayman Islands Monetary Authority (CIMA).

Roger Crombie: What effect is the Segregated Portfolio Company (SPC) Law having on the potential for such companies?

Wayne Cowan: We have seen a lot of interest in SPCs. We have put together two already this year and are currently working on a couple of very interesting SPC projects. Again, the challenge is to get the structure right, to enable the SPC to achieve its client's goals. We have therefore invested a great deal of time in putting together structures that are tax-efficient, as well as providing the desired insurance objectives.

Linda Haddleton: The only example of Segregated Portfolio CAT bond companies that we have seen thus far is a plan to put different tranches into segregated portfolios. By their nature, these deals are very watertight and do not necessarily need the benefit of segregated portfolio legislation. A high volume, multi-year, multi-risk deal could certainly make use of the SPC legislation. The finance houses designing the deals are not unaware of the legislation.

Charles Bolland: Much of the recent growth in new captive formations has been in SPCs. Sometimes the principals have very specific reasons for utilising the SPC structure; in other cases, it appears that the captive is structured as an SPC to provide structuring flexibility in the future. This is clearly a growth area for Cayman and the uses to which these vehicles can be put are still being developed.

Roger Crombie: Will recent growth in the offshore deferred variable annuity market continue and what has been Cayman's experience?

Gordon Rowell: The variable life market has certainly expanded, but the variable annuity market has seen little growth. Our entrance standards for formation are very high and only those organisations that can demonstrate high levels of business understanding and have the resources to provide the sophisticated services required by their clients are allowed to compete. For example, during the last 12 months, we have received five applications to form annuity and life companies, but only two were licensed because the other three did not meet the criteria.

Linda Haddleton: DVAs will work in Cayman. The big question is whether they work for the buyer. There has to be a certain amount of caution and care that the buyers and sponsors have taken their own advice on whether the product achieves their intention. Certainly, as a way of bringing together life insurance and investment expertise, there is potential for business from the more sophisticated high net worth individual buyers. So this will develop. Investment gurus will always compete for such investors with alternative products.

Roger Crombie: Have falling stock markets prompted changes in investment strategies among Cayman captives?

Wayne Cowan: During the bull market, clients were definitely moving more funds from bonds to equities. I have not seen much movement at all out of equities during this recent period of instability and falling prices.

Our clients recognise that their captive insurance portfolios are invested for the long term and do not appear to have concerns with shorter-term downward movement.

Linda Haddleton: In the last several years, Cayman captives have moved away from 100% fixed-income portfolios that guarantee preservation of capital to balanced portfolios that may enhance return and at the same time reduce volatility.

It has not been the best decade in which to experiment, perhaps, but the principle holds true, only more so for large portfolios, longer-term payout patterns. It is a safer strategy for the older captive that has built up surplus.

Many captives are not profit building, but cost smoothing for the buyer, and not all have long-tail liabilities. So they may not have surplus assets with which to speculate, or sufficient time within which to react, and should follow a different investment strategy.

Cayman captives have seen the effect of the falling stock market on insurers and have become more astute in financial credentialling and monitoring of the fronting and reinsurance companies that they will enter into arrangements with.

Charles Bolland: We have seen a trend of captives taking a larger exposure to the equity markets in recent years. It is too early to tell whether this trend will be curtailed because of recent events in the stock markets, although with falling yields on fixed-income securities over the past year, I expect many captives will continue to have an appetite for balanced portfolios.

Roger Crombie: How have the OECD and other initiatives affected Cayman? In what ways have these processes helped?

Gordon Rowell: Certainly, there has been expanded overseas attention on the actions of OFCs. As I have previously mentioned, we should welcome independent reviews of a regulatory regime in the same way that we require independent assessments of financial statements by auditors. Those jurisdictions that are co-operative and have a strong infrastructure have nothing to fear. From a personal perspective, it has increased co-operation and discussions with overseas regulators about a host of issues, not necessarily to do with problems but certainly everyday administrative matters.

Charles Bolland: The OECD and FATF initiatives have put Cayman's legal and regulatory framework under the international microscope. It is worth noting that many of the recent legal changes made by the jurisdiction were, in large part, a formalisation of what had been industry practice for many years. This is especially true in the insurance industry, where ‘know your client' procedures were already built in to the licence application process. In this regard, the process of legislating existing requirements has helped the jurisdiction, in that our compliance with international standards has become more transparent to the outside world.

Wayne Cowan: The clients that have come to Cayman expect the highest quality from this domicile, so they are welcoming the initiatives of the FATF and OECD. These initiatives ensure that the levels of compliance and regulation in Cayman are of the highest standard.

I have certainly not heard a single negative comment from clients and, indeed, the fact that we were not listed by either organisation has been a very useful marketing tool.

Roger Crombie: How do you view the proposal that had been before Congress to tax insurers outside the US?

Wayne Cowan: I would be very surprised if it passed.

Charles Bolland: Our view (based on informal discussions with PwC tax specialists) is that the proposal is unlikely to go ahead in its current form, given the weight of opposition to the it in the US and the results of a recent Internal Revenue Service study, in which the organisation was neutral as to the perceived abuses the proposal was seeking to address.

Roger Crombie: What particular issues is the Cayman insurance sector facing today that it was not one year, three years or five years ago?

Linda Haddleton: Three years ago, there was no noticeable international scrutiny of the way the insurance business was regulated in Cayman. There is now substantial scrutiny and Cayman has come out very well from the reviews it has received.

Charles Bolland: The challenge to the Cayman insurance sector five years ago was probably to diversify its captive base while maintaining its role as the domicile of choice for healthcare captives. This has been achieved through the offering of innovative products (such as segregated portfolio companies), specialisation in niche markets (e.g. cat bonds), firm but flexible risk-focused regulation and the continued emphasis on the provision of high-quality professional services in an attractive domicile.

The challenge to Cayman now is to build on its past success through proactive innovation, and meeting and exceeding the expectations of its users.

In addition, there will be continued focus on regulatory practices in light of global initiatives such as the FATF, OECD, IMF etc. However, Cayman has a robust but flexible regulatory regime that should be able to stand the test of international scrutiny. In this regard, CIMA is an active member of the Offshore Group of Insurance Supervisors, which is a member of the International Association of Insurance Supervisors and benchmarks its regulatory practices against those of other offshore (and onshore) captive domiciles.

Roger Crombie: Other than in ways that have already been mentioned, how will the events of September 11 affect Cayman?

Linda Haddleton: Anything that reduces market capacity and increases premiums always leads to additional interest in captives.

Wayne Cowan: I understand that losses from the appalling attacks are now estimated in the region of $35bn and may end up higher than that. This will obviously have the effect of reducing capacity on all lines of coverage.

Prices will increase, sometimes dramatically, and some coverages will not be available at any price. In an already hardening market I feel absolutely certain that the captive industry will see a sharp upturn in business. I believe we will also see more ACE-type companies formed, possibly by the larger brokers, hopefully in the Cayman Islands! In short, captives are about to see a further increase in business.