For the large, sophisticated multi-national, a captive syndicate at Lloyd's may offer a significant new location. Mark Wathen explains.
Captive owners are continually bombarded with new locations in which they can establish their captive(s). One of the main reasons for a country to open a captive domicile is to attract investment quickly into the local economy and they have tended to be those countries where a healthy service economy already operates; the Channel Islands, Bermuda, the Isle of Man and Dublin. The traditional attraction has been the tax breaks for captives. However, since the introduction in the mid-1990s of the Controlled Foreign Company Legislation in the UK, this former competitive advantage no longer holds true for UK multi-national companies, as these entities now have to remit the majority of their profits back to the UK at the standard UK corporate tax rate.
This factor, combined with the continuing soft market, the surfeit of capital in the insurance sector, global consolidation and other forms of emerging financial risk such as intellectual property are causing finance directors to re-examine the tenets underlying the operation of their captive as a risk financing vehicle. Furthermore, they are beginning to look at ways in which the role of the captive can be expanded and strategically positioned at the heart of the parent company's business operations, rather than remaining on the sidelines and waiting to respond to loss.
For far too long, the captive has remained in the background, invariably not having been licensed as an insurer in the territories in which the multi-national company operated. The front-line role has usually been assumed by global insurers who benefit from a global network and are able to provide services as a fronting insurer, reinsuring the risks back into the captive, while maybe taking minimal risk and a disproportionate fronting fee.
The new era begins
A captive at Lloyd's overturns this accepted playing field. The captive syndicate itself becomes the licensed insurer able to issue direct policies in over 60 countries, enjoying the benefit of the Lloyd's global franchise for no fronting fee. Furthermore, the captive is automatically positioned at the hub of the network from which all global service providers operate. The advent of captive at Lloyd's represents a new opportunity to dismantle and reconfigure the relationships.On 1 January 1999, Amlin Capital Management Limited, a managing agency responsible for managing corporate and captive syndicates, established the first captive syndicate SmithKline Beecham in the Lloyd's market, having worked on the captive initiative for a period of over two years since the introduction of corporate capital. Its vision is to make the captive work for the parent as an integral part of the global corporate risk management process, cutting out unnecessary blockages in the communication channels impeding effective cash flow, policy production and claims payments.
For whom the captive will work
A captive syndicate will not be a risk-financing panacea for all companies. Prospective syndicate owners will typically be substantial global corporations who currently pay sufficient premiums (over $10m) in order to benefit from savings in fronting fees, and those companies which are likely to be making use of local brokers and insurers to provide a range of local services to a wide geographical spread of subsidiary businesses.
Interest should be greatest from those companies whose desire is to concentrate their captive strategy in a single, rather than multi-captive structure. For companies fitting this profile, a Lloyd's captive can provide a number of significant benefits, the most important being:
• Access to licences in over 60 countries.
• The potential for avoidance of fronting fees.
• Enhancing premium cash and claims cash flow to and from overseas operations.
• Eliminating withholding and excise taxes such as FET in key territories.
• Simpler administration - policies, premium taxes/levies and other compliance matters.
• Control of international business.
• Capital provided by letter of credit (LOC).
• Quality rated Lloyd's paper.
The Lloyd's structure provides a wide range of services, expertise and capacity that is difficult to replicate internally and is usually not available from the global insurance players. This includes the ability to use the Lloyd's Policy Signing Office (LPSO) to provide an experienced view of Lloyd's market policy wordings, the taxation department to provide advice on corporate tax and premium tax related issues, the international department to provide guidance on licensing issues and who manage the local general representives' offices. The general representives ensure that Lloyd's complies with local legal and fiscal requirements and generally have a sound working knowledge of the insurance market and local practitioners.
On the converse, there are disadvantages which relate primarily to cost. Some aspects which lead to a higher cost of managing the operations of the captive include:
• Higher captive management fees than in other domiciles due to the amount of regulatory compliance required which is carried out by the managing agent on behalf of the captive.
• Capital requirements, although these can be provided by LOC, and the additional need for a parental guarantee which is not required for their party corporate syndicates at Lloyd's.
• Some lack of control, eg underwriting.
• Some potential element of mutualisation due to the Lloyd's Central Fund, although this is remote.
Each prospective captive syndicate will need to balance the extra cost that the Lloyd's syndicate will incur against the savings that will be achieved from reduced fronting costs, elimination of withholding taxes, greater independence, cash flow benefits and simpler administration within the risk management department.
If weighing the pros and cons seems to be quite a daunting task, do not despair for Amlin Capital Management Limited has devised a methodology for carrying out the cost/benefit analysis on behalf of prospective captives, provided that the necessary raw data is provided.
This feasibility study is designed to calculate the total expenditure set against the potential savings which the syndicate can make. Some of the criteria in the cost/benefit analysis include the following:
• Spend on fronting fees.
• Spend on withholding and excise taxes.
• Cost of capital compared to LOC.
• Cash flow from overseas subsidiaries.
• Value of quality paper.
• Subscription - 0.35% (of premium capacity).
• R&R levy - 1.1% (of written premium) - payable only until 2001.
• Central fund - 1.0% (of premium capacity).
• Higher management fees.
The benefits to Lloyd's?
As Lloyd's looks to source new revenue streams into the marketplace, as the premium base has remained static overall for virtually the last decade, the introduction of captives represents an opportunity for these clients to return to the market. Equally, it demonstrates the potential for renewed focus on the customer and their needs, not only merely concentrating on the traditional underwriting aspects, but going further than this and looking at servicing aspects using technology and maximising the aggregate benefits that come from being a member of the Lloyd's franchise.
Lloyd's initial drive should be to build on its reputation in the fields of marine, energy and aviation risks, UK motor and catastrophe reinsurance exposures where it plays a leading role in the global marketplace. In the marine, aviation and transport sector, there will be a concentration of significant global clients, where the existing relationships should be exploited to their fullest potential, involving integration of the traditional risk transfer mechanisms with their captive operations.At a time when access to business, client segmentation and relationship marketing is paramount, what better time to start viewing the captive sector as a new source of revenue earning opportunity.
For the large, sophisticated multi-national, a captive syndicate at Lloyd's may offer a significant new location. It offers:
• A presence at the heart of the London insurance market, a window on the insurance world and access to reinsurance markets.
• Direct writing without fronting arrangements.
• Credible, highly rated insurance paper.
• A sophisticated infrastructure.
From a wider perspective, the syndicate at Lloyd's provides the opportunity to extend the role of the captive in the context of the planning of multi-national programmes.
Looking forward, it is important that Lloyd's can learn from the messages which are being sent by the new captive entrants and that the promises it has made on cost structures are delivered. Aspects of the regulatory environment which need to be developed further include the whole issue of loss portfolio transfers, the level of parental guarantees and provision of greater flexibility in the nature and structure of captives - eg, allowing cell captives to compete with the like of Guernsey. A heady task list, but one that should not be shirked.
Mark Wathen is marketing director, Amlin Capital Management Ltd.