Interest in establishing European-based captives continues.
For several years, the possibility of a hardening in re/insurance market conditions has been viewed as the next big trigger in captive formation in European domiciles. In fact, other initiatives have aided the continued increase in European-based captives.
Foremost of these is the implementation of protected cell company (PCC) legislation in Guernsey. From a zero position in 1997, Guernsey now has 28 protected cell companies with a total of 136 cells, which has helped offset recent losses in the more conventional captive market. Guernsey, along with most other jurisdictions, has been feeling the heat of parent company mergers and acquisitions. In fact, it is this factor which led to Lloyd's losing its only captive, owned by pharmaceutical giant SmithKline Beecham, when the parent company was swallowed up by Glaxo Wellcome at the end of last year.
The future for captives at Lloyd's is looking thin at the moment. At a recent conference in the US, Lloyd's commercial director Roger Sellek intimated the market would not be actively marketing its captive facility, suggesting that a failed captive could expose the Lloyd's Central Fund – the fund of last resort for policyholders – to its losses. This suggestion led to a certain amount of outrage. Paul Bawcutt, chairman of consultancy RIRG in London, wrote in reply to Mr Sellek's suggestions:
“As someone involved in setting up the SmithKline Beecham captive and trying to persuade Lloyd's to encourage captives, I know that:
(a) captive syndicates, because of the onerous regulations and conditions, do not expose the Central Fund;
(b) a captive syndicate has to have approved aggregate stop loss protection, provide a parental guarantee, produce a fixed business plan, policy wording and reinsurance agreements before operation, so Lloyd's know (sic) specifically any worst case scenario is fully covered by the capital provider;
(c) the real reason for failure was unfriendly, bureaucratic and ignorant regulators and poor marketing.”
Lloyd's has subsequently remarked that Mr Sellek's comments were misinterpreted, and the market will continue to welcome captives into its fold. Whether parent companies – the vast majority of which will hold Lloyd's policies – will see any value of a Lloyd's-domiciled captive is questionable.
Finland's Aland Islands and Malta are other domiciles where the facility to set up captives has not attracted any takers. Despite friendly tax and regulatory regimes, captive owners still appear to prefer more established domiciles for their offshoots. Nevertheless, Gibraltar has been working hard to try to overcome this hurdle, and has seen a creeping increase in captive numbers, though in less traditional lines of business. With Spain still creating ripples in Europe in its relationship with Gibraltar – which under European law can transact cross-border business across the EU – limitations remain in the extent so-called ‘passporting' can be used. Gibraltar's attitude remains unbendingly sunny on the issue, and the government is in the process of bringing PCC legislation on to the statute books in an attempt to attract new business to the domicile.
Dublin's fair city
PCCs were seen in Ireland as potentially creating another revenue stream for the Dublin-based International Financial Services Centre (IFSC) regime. But regulatory uncertainty about their value stymied the proposals put forward by the Dublin International Insurance and Management Association following recommendations made in a position report commissioned from Tillinghast-Towers Perrin in the late 1990s. Since then, the whole financial regulatory regime has been scrutinised and currently is in the middle of fundamental change.
Monetary policy and financial services regulation are being combined into a single regulatory authority, the Central Bank of Ireland and Financial Services Authority, chaired by the bank's Governor. At the time of announcing the regulatory overhaul, Minister for Finance, Charlie McCreevy, said, “We need to ensure that there are no obstacles to an effective regulatory system,” while Tanaiste Mary Harney commented, “Our goal is for Ireland to be a leading global locations for the financial services industry.” Recognising the ever-tightening relationships between banking, insurance and investment services, she commented, “Our regulator must be able to deal with these developments quickly and proactively. We need a model of regulation that is neither too heavy nor too light, but tuned to consumers' needs and responsive to industry's innovation.” It is too early to say what effect the regulatory changes will have on captives domiciled in Dublin, but local managers seem convinced that it will have little impact.
The changes in the tax treatment of Dublin-based captives, following the end of the EU-approved 10% tax regime for companies located within the IFSC, had only a temporary impact on captive formation in the jurisdiction. Once the European Commission had decided not to allow an extension of the tax regime beyond 2005, the Irish government responded pragmatically by bringing down corporation tax stepwise, finishing at 12.5% across the board next year, including both domestic and international business.
Changes in the legislative environment have taken place in Guernsey too, extending the PCC regime to a wider range of companies. In particular, securitisations can now use PCCs as part of their structure. Already, Guernsey has seen a few such deals come through, and more are expected as risk professionals come to terms with the number of different uses for PCCs. This is expected to be the main area of growth for the Guernsey captive industry, as alternative risk finance becomes more mainstream, and will offset the steady decline in UK-owned smaller captives as controlled foreign company (CFC) and insurance premium tax (IPT) changes implemented by the UK government lessen their attraction.
Traditional captives are also slowing in their growth in Luxembourg, a domicile famous for its equalisation reserves. In recent years, the French tax authorities have been increasingly concerned about the tax treatment of some French companies with operations in Luxembourg, where tax liabilities can be deferred using catastrophe reserves of between 12.5 and 20 times the captive's annual net premium, averaged over five years. This is thought to have detracted from French companies' view of setting up captives in what has, until recently, proved the country's most favoured domicile. But recent cases in the French courts have found against the French tax authorities and Luxembourg captive managers foresee future growth as a result. In addition, the hardening re/insurance market could well be a trigger for future growth in captive numbers, they say.
Meanwhile, the Isle of Man has seen numbers decline, though, again, a rise in re/insurance premiums is expected to trigger a new wave of formations on the island, which has been hit by the UK government changes in CFC and IPT treatment. PCC legislation is yet again another prospect anticipated by Isle of Man captive managers, though so far the regulator has not looked favourably at the proposal. Nevertheless, captive managers are hopeful the success of Guernsey will lead to the regulatory authorities relaxing their stance.