Global Reinsurance correspondent Roger Crombie welcomed Steven Butler, financial director of Chandler Insurance Management; George Craig, an attorney with the insurance unit of W.S. Walker & Company; Tom Clark, director of HSBC Financial Services (Cayman); Wayne Cowan, senior vice president and branch manager of J&H Marsh & McLennan; Ian Kilpatrick, president and ceo of Crusader International Management; William McCullough, head of insurance supervision at the Cayman Islands Monetary Authority and John Pitcairn, president and ceo of Mutual Risk Management (Cayman) to a discussion on a range of issues relating to the Cayman Islands, held at the Landmark in George Town, Grand Cayman.

Roger Crombie: Growth in the international business sector has become a way of life in Cayman for many years. Is it the general feeling that this can continue?

Ian Kilpatrick: Having lived here for 27 years, every year I say you cangive it five or ten years more, and every year I am proved totally wrong. It is absolutely unbelievable how growth has continued here over the years, but at some point in time, it must reach a plateau. Not so much from the business side, but because the infrastructure of the island is not going to be able to cope with what seems to be double-digit growth every year. So, how long it can continue to function? I do not know. In the financial industry, I see no reason why the brakes should be put on, even with the Organisation for Economic Co-operation & Development (OECD) initiative on the horizon. I think that it would be the infrastructure and the problems attendant with it that would slow any growth here.

George Craig: I think we have also broken through into a new kind of marketplace. Since I have been here, almost three years, working as a lawyer, we have seen ourselves move from the capital markets/mutual funds/insurance sector, from a purely offshore sector, to become a competitor with Dublin and other areas. So we not only have the traditional work which has always been coming into the Cayman Islands, but we are now getting new work, very high quality work, because we are seen more and more as a more legitimate jurisdiction for any kind of international organisation or institution. From a lawyer's point of view, we see a lot of very different kinds of work coming in all the time, particularly capital markets and fund work.

Wayne Cowan: I think another factor is the prosperity of the United States which, from a captive insurance point of view, has always been traditionally our major market place. It is always said if the States sneezes, we catch a cold down here and I think that the prosperity of certain world economies, including that of the US, plays a part in the prosperity of this island.

George Craig: And also the recognition. The fact that we have beenincorporating more captives and other insurance vehicles year on year for a few years now, has to say something about the fact that people are recognising that the jurisdiction has become more respectable and is a real competitor with any other jurisdiction in the world. Not only are we getting new work clients with ties to the US market, we are actually competing at a higher level, with others at the top of the market.

William McCullough: One of the fortunate points about being attached to the US market, from which we get 80% of our business, is that most of the innovation and change which has occurred has taken place primarily in the US market, not from the European market. Because we are closely associated with the US market, much of the business is coming to us. I think it is going to continue to come to us, because the most recent changes in the markets, the convergence of the capital and financial markets with insurance, have arrived in Cayman mainly because of the opportunity that is available here in the legislation and the fairly quick response that the public and private sectors have made to the legislation.Because of that, we left Bermuda behind on two very specific occasions in the last two years. I am seeing people talking to us now about different things than they were two or three years ago. This credibility situation which has arisen over the last few years in the capital markets, in the catastrophe bond issues, in the area of securitisation, is inevitably going to lead to further changes. I think that, from the year 2000 onwards, it is change in the market that is going to promote the growth of captives and offshore business and because Cayman has been seen to be responsive to change and has established the credibility factor that we have talked about, I cannot see it doing anything other than continuing.

Steven Butler: I would agree. I would not agree necessarily with Ian that growth might slow down because of structural restrictions. I think growth may slow down because of the US economy slowing down, particularly when the stock market in the US starts its downturn, which some of us have been expecting for a few years now, although the stock markets just seem to be going further and further up. When that does finally turn around, I think we will see a slowdown in the rate of growth of captives, but I do not think it will be anything from the Caymans' structural point of view that will contribute, I think it will be more related to general market conditions.

Ian Kilpatrick: That is interesting, Steve, because when the stock market does turn down, I think there will be a need to return to a basic attitude of: Let us look at our costs and see where we can make some returns we have not been able to make in the stock markets. While we have had a considerable number of new captives formed in the past few years, if you look back historically - and I have no facts in front of me - at the American economy in previous slowdowns, I do not think you would find that much of a slowdown in the formation of captives.

Steven Butler: That is a very good point. The question I was asking was: Will there be the availability of extra cash necessary to establish captives in bear stock market conditions? But the point you make is a good one.

George Craig: If that were to be the reaction to a slowdown, it would be a global reaction.

Tom Clark: What we have seen in the last couple of years are some fairly innovative products coming to the island as insurance companies, although they are not captive insurance companies, and over the last 12 months, variations on those products. I think as long as there is change in the markets, now that people are starting to look at Cayman as a domicile for these new investment-insurance products, we will see innovative people bringing us new products. I think that if the stock market goes down, investors will be looking for higher returns somewhere else.

George Craig: The debt market over the past couple of years, especiallyafter the US crash, has undoubtedly benefited the insurance industry,because people now have a much more diverse attitude to investment and a much more diverse attitude to risk. And they will look to try and securitise insurance risk with different kinds of financial products besides equity, which is now part of a portfolio, rather than an entire portfolio.

Roger Crombie: Does Cayman need to improve its reputation?

William McCullough: We can always improve; there is no question about that. I always ask new companies that are coming down here why they have chosen Cayman. The factor raised, almost every time, is the depth of knowledge and experience of the lawyers, accountants and auditors and the insurance managers, which is expanding every year. Since we became involved in the securitisation market a few years ago - we captured 12 of the first 15 - the knowledge and ability shown by the managers here has, in fact, gone further than that. It has shown that Cayman has a depth of knowledge that is scarce in other parts of the world. I believe that we stole a march on the securitisation market because of that, and since then people are looking at the Cayman Islands for opportunities that are not necessarily available elsewhere.The response from the market here has been that, because we have been seen to be responsive to earlier requests for different products, there are more and more ideas being put forward. The extension into life reinsurance, which has happened over the last 12 months, has happened as a result, I am certain, of the exposure that we have had to those changes that we took up and ran with last year.The other big issue that I have been involved with over the last 12 months has been in the life reinsurance market. We do not intend to compete with other jurisdictions that have substantial reinsurance markets; we decided that was not the direction we wanted to take. But it seems that, having decided that we were going for the middle-of the road business - we were looking at introducing legislation for segregated portfolios and had the legislation available for securitisation - that other players were realising that, perhaps, Cayman does have the opportunity for other products, and these products are developing in the reinsurance market. Two years ago, I would have said that we did not have the facilities for the reinsurance market, but it is happening anyway.The life market has probably developed on the basis that we had a very strong variable life market established through the captive side, and the promotions that some of the bankers have made at various conferences have indicated to people that there is more to the opportunity in Cayman than just the traditional captive market. Most of our new captives this year have not been from the traditional captive market.

George Craig: Also, in terms of the insurance managers and other serviceproviders, not only do they have real skills comparable to those found in any jurisdiction in the world, I believe, but we also have goodwill and real focus from government and the regulators. We can only react to a new proposal in light of the manner in which the regulators have received it. We might be asked to look at the mutualisation of an insurance vehicle, for example, or a cat bond. We would go to the regulators and say: No one else in the world is doing it, can we do it? Instead of responding: Well, it is new, so we should be very cautious. The regulators look at it and if they find that it is a good idea, they say: Well, no one else in the world is doing it, so we will beat the market.

That has been the big difference in the past three or four years and there actually is a proactive edge to regulation and legislation which makes Cayman user-friendly for outside organisations. We have a very good level of practical, hands-on regulation internally, without it being too obtrusive.

Ian Kilpatrick: I think that is evidenced by the fact that the insurancelaw itself has written into it a requirement that the insurance managers also be the policemen for the Insurance Department. We have never wanted to have a very large bureaucracy and the insurance managers have, over the years, advised the department of situations with clients when, perhaps, a strong letter is needed. And as a result, a reservoir of goodwill has grown up between the private sector and the regulatory department.

Steven Butler: I think all of these things have contributed to Cayman's good reputation among those people who are aware of the offshore insurance industry. When we talk about reputation, I think work needs to be done among those who are less familiar with what goes on in the different jurisdictions. As we speak, both the private sector and government have their own initiatives going to teach the general public in the UK, and to a lesser extent Europe and the US, what goes on in the offshore financial centres. But I do believe that among people who know about Cayman, our reputation is good and it has been getting better.

Wayne Cowan: We have legislation which has been in place for several years, and have kept up with the legislative changes required to supervise the activities of the managers and professionals in Cayman. We have the Mutual Legal Assistance Treaty, we have the Proceeds of Criminal Conduct Act, we have codes of practice. Cayman has been very aggressive in pushing suitable legislation through.

John Pitcairn: One of the advantages of the insurance sector vis-à-vis other industries in Cayman is that, after the advent of the 1996 Tax Evasion Act in the US, which many thought would sound the death knell for captives, there is now no real tax advantage for founding a captive insurance company. It gives me great comfort to know that the vast majority of my clients are paying tax in the US at the corporate or individual level and when we are also dealing with reputable fronting companies, there is a lot more known about the people we deal with than is, perhaps, the case in other industries.

George Craig: Further to what Steven said, the Cayman Islands does not have a public relations machine in the same way that other jurisdictions have. It is a compliment that we have the level of reputation that we have without having created it ourselves ù but it is also a criticism because in today's market, you have to go out and tell people how good, and how different, you are. We do not, as a jurisdiction, do that, although many of the insurance managers are more proactive in that area.

Ian Kilpatrick: I have a concern that, these days, it seems that legitimate tax avoidance is not perceived as distinct from tax evasion. As the owner of a small private management company, my clients are not necessarily large corporate entities. One advantage in the area of variable life and variable annuities is the legitimate tax benefits which can be achieved by having policies issued by offshore carriers. My great concern is that there is a movement towards the big, corporate capital markets and that the small private individual might be left behind or left out. That would be a shame, because there is no reason in the world why people should not be prudent enough to handle their affairs in a manner that will cause them to pay, quite legally, the least amount of taxes.Unfortunately, in this politically correct world it seems that behaviour is now considered inappropriate and I think there is a danger that government will sit back and decide that we need only these big multi-national names. There is a need to provide service to smaller entities. Not everybody, with all due respect, wants to deal with a Marsh; some prefer to have a smaller company and I get the impression, as a small entity myself, that government thinks bigger is better. I hope that during the continuing dialogue between government and the private sector, we will be able to get it across that there is a reason for smaller management companies.

Steven Butler: You make some very good points. It is my understanding that government has recently spent a lot of time looking at the evasion and avoidance issues and is now very aware of the importance of tax planning to individuals as well as to corporations and is prepared to put Cayman forward as a jurisdiction for both. I do not think it is bad as Ian thinks.

George Craig: Onshore jurisdictions are currently very suspicious of anywhere which has “tax-free” written on it and there will always be the mind-set that those words mean you are doing something wrong.

Wayne Cowan: The real problem is that there is a very real blurring of the distinction, as we have seen with the OECD, between evasion and avoidance. The OECD had no clear distinction between the two, which is a problem we face in the offshore industry.

Ian Kilpatrick: You could argue that Cayman was originally a tax haven, but it has progressed since then to become an offshore financial centre and, subsequently, a financial centre, but what worries me is that there may be one or two skeletons in the closet from the early days. Were they to emerge, no one is going to be able to distinguish between what was happening in 1972 and what is happening in 1999, which is completely different.

George Craig: I take that point, but it is worth mentioning that thingshappen in even the most heavily-regulated jurisdictions. Take New York. We have just seen that, despite all of the regulations in New York, things can still go wrong.

William McCullough: I think it is important to recognise what John said,that most of our captives, and certainly all of those that we have beeninvolved with in the last couple of years, are legitimately paying tax in the US and taking advantage of the captive market for reinsurance facilities and risk management insurance operations in Cayman. It is not tax-driven any more. It has changed; Cayman is not a tax avoidance situation for most of our companies.

Roger Crombie: Are the Cayman Islands likely to appear on the final OECD list of “tax havens” next May?

William McCullough: I can think of no reason why the Cayman Islands should be included on the final list of jurisdictions deemed to be providing harmful tax competition. Legislation has been introduced and we have a high degree of regulatory requirements and compliance in force here. I am sure we will come out of the current review process, provided it is carried out within the required parameters, with a clean bill of health.

George Craig: Tax harmonisation, as intended by the OECD, will prove to be very difficult to put into practice. I would have thought that any jurisdiction that can demonstrate, on an ongoing basis, the controls it has in place, and which has an ongoing dialogue with other OECD countries, would not be put on any particular list of actions to be taken by the OECD.

Wayne Cowan: I would go one step further. The regulations and the “know your client” rules that we have here are such that, if we were placed on the final list of offending havens, I would find it very difficult to imagine who would not belong on that list, including the major centres of the world, the Londons and New Yorks and Hong Kongs. We have regulation in place that is far more stringent than that in other jurisdictions and we have a very high quality of professional advisors in Cayman. I would find the inclusion of Cayman on a list of harmful jurisdictions inconceivable.

William McCullough: There is going to be a requirement - there already is a requirement - for members of the international associations of insurance regulators and supervisors to adhere to proper principles that have been outlined in various papers, although not yet made mandatory. Cayman complies with all the international standards. Some of the European countries do not conform to the standards that we do, because of the way things were done in the old days. We are moving forward to be in compliance with these principles - and so we are a step ahead of a lot of other countries.

Roger Crombie: There is a perception that a potential corporate investor simply has to come to Cayman, have a word with a professional advisor and the regulators, and, without further ado, be in business. Is that right?

Tom Clark: That is not quite right. Someone coming down from the States would speak to their professional advisor, who may indeed be able to quickly get an appointment to see or speak to the regulator. He may very well give a quick answer, which may be yes, if the idea is appropriate. But the answer may, just as quickly, be no, if what you are putting forward is not appropriate.

George Craig: The real value to the businessman coming to the island, aswell, is that they can get an indication, up front, of whether something is going to fly or not, before they go to too much expense in setting up formal business plans. They can actually sit down and speak to the regulator in a direct and informal way and be told whether a concept, in principle, is acceptable or not.

Roger Crombie: One new product which has received regulatory approval in the Caymans lately is catastrophe bonds.

Tom Clark: The island was fortunate to be approached to see if we could structure and manage some of the earlier cat bond deals that were structured in 1996. The first was launched in 1996 or 1997 and received a large amount of publicity. The concept of a charitable trust owning a company and that company taking funding from investors to provide security for certain protections was not new. The lawyers and some of the trust companies on the island have been doing special purpose companies for probably 10 or 12 years or longer, so the island had lots of experience in its service providers helping with the input needed to make it work. What we were fortunate to be able to do was to speak to the Monetary Authority, Bill in particular, and describe the transactions to him and obtain his approval for these new types of investment, of risk securitisation. The deals have clearly been successful. We have been involved in 12 of them, out of a total of ...

William McCullough: ...16 on the island so far, not counting this year's.

Tom Clark: These deals are very attractive to the investors in the bonds. They do not like the idea of hurricanes, but they do like the idea that the risk associated with these deals, from an investment point of view, is a hurricane risk, for example. If they have an investment in their portfolio that is a hurricane risk, that is not correlated with risks of a depression in the US, bank share prices being depressed and so forth. Hurricanes tend not to do that, so you put some hurricane-related risk in your portfolio and that reduces the volatility of the portfolio.These deals are particularly attractive to investors and to insurance companies that are using these special purpose companies for insurance. The reinsurance companies also like them because they know that, if there is a claim, they will be paid. The security of these companies is absolutely first-class, because 100% of the risk they are taking is represented by assets in the bank, with a secured charge over it in order to protect the insureds and the investors.

William McCullough: From the regulators' point of view, our criteria have been very simple: We will only discuss it and proceed with it, if there is a specific transfer of risk, for example from an insurance company to a reinsurance subsidiary, or to a charitable trust set up by a reinsurer. There must be a pure risk transfer as a cession from the originator to the company in Cayman. We have been asked in the last couple of years about securitised insurance vehicles here which, in my view, have not accepted a true insurance risk transfer and we have said no. Even on financial risk vehicles, the criteria have always been the same: a risk must be transferred to the Cayman Islands. Otherwise, we will say no.

Wayne Cowan: One of the reasons that Cayman has emerged as a major domicile for writing these types of securitisation risks is that, again, we had the professionalism in place, but also because up front, we could run the business plan for these securitised risks through the insurance regulator prior to the sponsor of the programmes embarking on what is two or three months of very hard work for the attorneys, the brokers and the investors.

William McCullough: Some of those deals that we have not gone along withhave been trying, in my view, to use a legitimate licence of an insurance company in Cayman as part of their IPO or sales pitch. We do not want companies to be seen to say: Cayman regulators have accepted that this insurance company is legitimate and, therefore, our credibility is going to be very strong. As regulators, we do not want to legitimise any situation where a transfer of risk does not take place, because that would erode our own credibility.

Roger Crombie: Another new product in Cayman is variable life annuities.

Ian Kilpatrick: The first thing to say about offshore variable life and variable annuities is that all the companies that are offering them are offering exactly the same product that is available in the US. There was an immediate belief that people would move offshore because of some efficient tax benefit or some reason connected with tax, but that is, probably, far from the truth. Any insurance policy in the US, particularly a life insurance policy, as long as it complies with the definition of a life insurance policy under the IRS code, offers a tax-free build-up of the investment income and capital gains.One of the main reasons that the offshore insurance companies have beenformed is that, because of the segregated cell legislation and the more relaxed approach to regulation - a poor term, because it infers that there is less regulation - so let me put it this way, because there is less bureaucracy here, insurance companies are able to diversify their portfolios and make investments which are not available in the US.

If you went to an insurance company in the US to purchase a variable annuity, you would give them, usually, a single premium and they would offer you a basket of mutual funds to choose from. The funds would be managed under their name by any one of the major mutual fund companies, but you are very much limited by the type of investment you can put into the annuity. Whereas, for a purchaser of a variable annuity in the Cayman Islands, the insurance company would place that single premium into a separate, segregated company in their accounts. That separate, segregated account removes those assets from the general assets of the insurance company and it also removes the assets from any other policies.

An account is set up for each individual policy. The ultimate policy benefits will be based on the value of that segregated account. This means that the insurance company is allowed to make more aggressive investments within that segregated account.

One of the major thrusts towards variable annuities was started by the hedge fund companies, who wanted to wrap the annuity around their fund, which they would never have been able to do in the US. So you will find that insurance companies in Cayman Islands, within their segregated cells underneath the policy, have a much broader range of securities, probably with a higher risk tolerance, than annuities in the US. The segregation also allows a substantial gain to fall within that segregated account, which would not be available under a policy in the US. It is this flexibility of investment that has driven the considerable interest in variable life and variable annuity policies over the last few years.

You will see annuities that have hedge funds, currency funds, commodity funds and even more exotic investments; the reason is that ultimately the payout is based upon the value of the account. If you give me a million dollars and your investment advisor turns it into $10 million, that is what we will pay out on. If he does not do as well, and turns it into $500,000, we would pay out on $500,000. In fact, the insurance company cannot just take the value of a segregated account and pay it out, because one of the major IRS requirements is that there has to be a transfer of risk and risk distribution, so most insurance policies - certainly on life, because it is very easy to define a life - but also on most annuities, the insurance company does assume a portion of the risk. There are many different ways of setting it up, but there is always an element of risk assumed by the insurance company.

Roger Crombie: Are there other new products on the horizon?

John Pitcairn: Last year's implementation of our segregated portfolio company legislation has been very successful. Quite a few people are coming through to set up individual segregated companies for various reasons, so I see strong and steady growth in that regard.

Steven Butler: I am waiting to see if we get enquiries in the slowly growing area of e-commerce and whether specific lines of coverage are going to start coming in for what they are calling cyber-risks. That may be a new area we can look into to help business.

Roger Crombie: Might the development of e-commerce in Cayman be hamstrung by the cost of telecommunications?

Steven Butler: Less so than we were before rates were reduced early inOctober.

Ian Kilpatrick: The size of the pipe also causes us problems, as much asthe rate.

George Craig: While the service providers would like to see those costs come down, to make us as competitive or more competitive than other offshore jurisdictions, most larger clients do not really notice those costs. It can be a negative for individuals or smaller organisations who work from the Cayman Islands. It is a balancing act for the government. On an ongoing basis, I think we will see those prices coming down and the monopoly will be better regulated or exploded.

William McCullough: As to e-commerce, many countries are grappling with this on the regulatory side. There are so many agencies commenting on the validity of the contracts and the signatures, that there will need to be legislative changes to Cayman laws to allow it to move forward. I am a little hesitant to say that we can immediately open the door to e-commerce. I still have reservations about the validity of the contracts and the opportunity for it to be misused. I would rather maintain our credibility on a traditional basis for a little while longer, until somebody else, perhaps, has tested the necessary legislation.

George Craig: It is a very difficult area, and every jurisdiction is having problems with how to ascertain whether or not there is a valid contract out there. Some people are using different kinds of pass codes, others are setting up advance contracts. I think the best hope for the moment is to try and establish the basis of a contract and, following that, there is an executed document - not only to keep a lawyer in a job, but to establish the validity of the arrangements between the parties. Certainly, in terms of contact, negotiations and communication, e-commerce has taken hold and will continue to do so.

Ian Kilpatrick: It is absolutely fascinating in relation to the variablelife and variable annuity business. One of the benefits, of course, of coming to an offshore insurance company is that maybe it can provide greater flexibility and returns, but one thing it cannot do is to sell insurance policies in any domestic jurisdiction, particularly the US. If it did, firstly, it would be subject to US taxes and, secondly, it would probably be in breach of every single state insurance regulation. So most offshore life insurance companies go to extremes to ensure that they are not seen to be doing business in the US. They require all of the insureds, usually, to go outside the US, preferably to the domicile in which the insurance company is located, to execute the application forms, to undertake the medicals and to have the policy delivered in the offshore domicile. And yet major multinational companies in the US have set up offshore operations and opened websites on which you can get an application form and fill it out. It is absolutely amazing that you can do that.

George Craig: National regulators throughout the world are grappling with this as well. The self-regulatory organisations and the Treasury in the UK have been trying to decide, from an investment and an insurance point of view, where offers were being made in the UK, was it by having a website or by promoting that website? There are no universal standards as yet.

John Pitcairn: With the rate at which technology advances, it will not be long before the world is on a level playing field.

Steven Butler: I think most business people in Caymans would agree that it is more important to keep up to date with the technology, to keep that investment going, than to keep down the cost of individual calls.

William McCullough: Without knowing exactly what level of e-commerce we are talking about, we effectively insist that we meet all of our potential clients, all of our potential licensees. I personally would not want that to change because I like to know exactly what people are doing, who they are and why they are doing it. I would be mistrustful of any electronic discussions in terms of licensing requirements.

Roger Crombie: Cayman is starting to develop its own reinsurance sector. Is the island ready to cope with even greater growth?

Ian Kilpatrick: We have a phenomenal opportunity to build in the eastern part of the island, whether it be condominiums or other forms of development, but how much longer can Cayman take the deluge of people that are coming into the island? This is a major cause of concern for Caymanians to see their culture completely overrun and yet the business is there. There is no limit to what can be brought in, but it has to be balanced with the thoughts and feelings of Caymanians.

Wayne Cowan: We have, I think, 13,000 people on work permits out of a total population of 39,000, which is a higher ratio than, say, Bermuda. Although the physical land can stand the development of the infrastructure, it is indeed a fine balance. I think the business is out there, but it depends upon the capabilities of the infrastructure and how Caymanians will accept the changes.

Ian Kilpatrick: I would have thought that there were more than 39,000 people here. I am looking forward to seeing what the census says. I am sure there is going to be a surprise.