More sophisticated risk management techniques combined with tighter conditions in the conventional re/insurance market bode well for captive formations around the world.
In little more than a decade, the captive industry will be celebrating its first centenary. Not bad for an industry which is still described by many as an ‘alternative' form of risk transfer. To be fair, captive insurance companies started coming to the fore in the 1960s, and since they entered the risk management tool kit their popularity has continued from strength to strength.
Now, almost 4,500 captives exist around the world and those numbers are destined to increase. In the recently-published Best's Captive Directory, analysts foresee that hardening conditions in the conventional re/insurance market will have a knock-on effect on the captive market, as organisations decide to follow the self-insurance route rather than pay higher prices for less coverage. “Sustained price increases will only increase the likelihood that sophisticated insurance buyers will more seriously consider an alternative market solution over the mid-term,” the analysts predict.
According to the directory, captive numbers increased by 2.4% in 2000, reaching 4,458 globally. Although this figure appears lower than the previous year – 1999 to 2000 saw a 5.3% increase – this is partly because of the acceleration in segregated accounts companies. These incorporate a number of individual ‘cells' into one captive insurance company, with surrounding legislation preventing the failure of one of the cells to impact the liquidity of the rest of the captive's participants.
According to AM Best, calculating each cell as a separate captive would bring up the year-on-year increase in overall captive numbers to 6.2%, a reflection of the increasing number of mid-market companies availing themselves of a risk management strategy previously too expensive to be worthwhile. During the course of last year, Bermuda joined Guernsey and the Cayman Islands as one of the few jurisdictions with enabling legislation in place to offer segregated cell companies.
So far, most domiciles have been wary about putting into place regulations for protected cell companies (PCCs). For example, Gibraltar has had legislation drafted for several years to facilitate the entry of PCCs into the domicile but which so far hasn't been added to the regulatory rulebook, even though there is a similarly-constructed captive already established in the jurisdiction. That PCC legislation has yet to be tested in any court around the world may be a reason why Gibraltar is hanging back on implementing its own law, which is based on that passed in Guernsey in 1997.
But Bermuda decided to take the bull by the horns and pass the Segregated Account Companies Act 2000. “Bermuda has always been in the forefront of these structures, having enable them by way of private legislation for the last decade,” explained Bermuda's Premier, Jennifer Smith, to an industry audience last year. “This particular piece of public legislation was a long time in development. We took the time to analyse the legal, business and public policy requirements and we think we have got the resulting statute right. It provides for fast, effective and responsible segregation of assets between client accounts and I believe will make Bermuda even more effective as a jurisdiction in which to structure insurance derivatives and structured reinsurance transactions.”
At the same time as Bermuda was passing segregated cell legislation, the US state of South Carolina passed captive legislation, and by the end of last year had already seen six captives establish, two of which were redomiciliations from other US states. It hopes to have doubled this number by the middle of this year, and has enacted legislation enabling reinsurance carriers to discount reserves. In return, the reinsurers must have at least $500m in capital and invest a minimum of 35% in the state. This aggressive marketing of the domicile is an indicator of just how fierce the competition is between the different jurisdictions. Of the US onshore domiciles, Vermont was the first, and remains the busiest with 489 licensed captives last year, according to the Best directory, although it lost one to South Carolina. Vermont-based captive practitioners are hoping to pass the 500 captive mark by the middle of this year, despite the influx of tough competition from other states. Some, however, haven't seen the South Carolina experience: despite implementing enabling legislation two years ago, Nevada has just two captives. Nevertheless, this has not detracted others enacting legislation over the past few months, the most recent being the District of Columbia, and there is a general feeling that Montana could well become captive-enabled before the year is up.
As well as new jurisdictions, captive parents are seeing a wider application for their subsidiary captives. As workers' compensation, healthcare and medical malpractice costs have shot up in the US, so has the interest being shown in putting these types of liabilities into captives. In particular, last year's US Department of Labor ruling on the Columbia Energy Corp captive, which allowed the parent to put its employee benefits program into its captive, is likely to open the floodgates for other US organisations.
Whether offshore captive domiciles will be able to continue to compete on the tax ticket following last year's investigations into harmful tax competition and financial regulation standards is a major question mark hanging over certain jurisdictions. Although most domiciles protest that taxation consequences are no longer important in the decision-making process for setting up a captive, there is little doubt that it can have a profound effect. Kathryn Westover of Strategic Risk Solutions suggested that the four main factors influencing domicile selection are taxes, regulations, infrastructure and perception. The first three are key in the cost equation, she commented, with taxation being the “single most important operating cost” in a captive program.
Ultimately, though, the reputation of the domicile can be the deciding factor in the decision of where to locate a captive. As well as historical reputation, shareholder culture and provider preference need to be taken into account when selecting a jurisdiction, she argues. Thus domiciles such as Bermuda – the jurisdiction with the largest number of US offshore captives – have been eager to flag the ‘cleanliness' of their jurisdictions following the Organisation for Economic Co-operation and Development (OECD) and KPMG reports. Other offshore domiciles which stand out in last year's figures include the Cayman Islands, with the greatest number of captives, and the British Virgin Islands, with the fastest growth over the year.
Of the 4,500 captives currently writing business, about 1,000 have US parents. Although smaller companies are beginning to access the captive concept, the Best captive analysts predict that the greatest captive growth will come from Asian and European parents.
Again, competition between domiciles for this business remains fierce, with jurisdictions such as Dublin selling themselves on the time zone, infrastructure and language tickets. Growth from prospective parent countries such as Italy and Japan has been slow to date, but again the hardening conventional market may push commercial and industrial organisations down the captive path. With the captive industry estimated to be worth about $28bn, and Best estimating that the proportion of the US property/casualty business going down the ‘alternative' route will lift to about 50% in 2003, it is hardly surprising that the scramble is on.