Paul Anderton, Rob Jenkinson and Charles Bolland poll the island's insurance management community and analyse Cayman's diversified international insurance sector.
Much has been written over the past few years about the relative merits of the Cayman Islands as a domicile for offshore insurance companies. Our intention is to focus on recent trends and current developments in the Cayman offshore insurance industry in order to provide an insight into what factors are perceived as being of importance to its future development. We have sought to do this by:
• Analysing the captive insurance company statistics produced by the Cayman Islands Monetary Authority (CIMA) for the past three years.
• Discussing industry developments with the CIMA and the leading insurance managers in Cayman to identify current and future trends.
It should be stressed that we have not conducted a formal survey of the Cayman insurance managers; rather, we have conducted a straw poll of selected insurance managers.
We have also sought an external (i.e. non-Cayman) view by asking Richard (Rick) M. Price, a senior consultant in the PricewaterhouseCoopers actuarial and insurance management solutions consulting group in Atlanta, Georgia to comment on our findings.
The statistics referred to in this article were obtained from the insurance department of the CIMA. The years referred to are calendar years/year ends, except for 1999 which refers to the nine months ended or as at 30 September 1999.
Of necessity, our analysis is more in the nature of subjective interpretation of the statistics than a genuine quantitative analysis.
Trends in new business over the past three years
1. By type of structure
The bar chart below illustrates the growth in the number of new formations in the period from 31 December 1996 through 30 September 1999.
The following definitions are used by CIMA:
• Pure captive: single parent captive (parent only risks);
• Association captive: an entity which provides cover to a collection of companies in the same industry, or with similar characteristics, with those companies having some ownership interest in the captive;
• Group captive: an entity which provides cover to a collection of companies in -different industries and/or with different characteristics, with those companies having some ownership interest in the captive;
• Open market insurer: a writer of third party business (for example, issuers of deferred variable annuity policies);
• Rent-a-captive: a vehicle established by a promoter to provide captive-type cover to third parties in return for management fees;
• Alternative financing: primarily risk securitisation vehicles;
• Segregated portfolio companies (SPC).
The statistics for the types of structures used in Cayman demonstrate that:
• Over 60% of all Cayman captives are pure captives; the basic captive is still by far the most popular vehicle, with continued steady growth year on year.
• A total of 16 alternative financing vehicles were licenced in the two years ending 31 December 1998. This category includes the special purpose vehicles (SPV) used to securitise risk and access the capital markets, such as catastrophe bond issuers.
• Fourteen segregated portfolio companies (SPCs) have been licenced following the introduction of new legislation in 1998, permitting the segregation of separate pools of assets and liabilities within one entity.
One piece of information not provided by these statistics is the number of unsuccessful licence applications. We understand from the CIMA that every year it rejects a number of licence applications. The reasons for rejection vary. The message is that Cayman regulators are known to be flexible and approachable, but they are prepared to say no.
2. By primary class of business
The chart below shows that: the make-up of the number of licenced captives by primary line of business has remained relatively stable over the past three years.Captives with healthcare, workers' compensation or property as their primary line of business make up 75% of the net increase of 78 new licences issued less licences cancelled from the end of 1996 through 30 September 1999. Most of the special purpose vehicles (SPVs) set up to access the capital markets are included within the property category.
Healthcare captives have consistently comprised one-third of total captives and account for just over a quarter of premium volume. CIMA attributes the increase in premiums written in this category in 1999 to (a) an increase in long-term care business which typically generates large premiums from the variety of coverages that it includes, such as workers' compensation and general liability, and (b) an increase in working layer risks in existing healthcare captives, as their increased capital base and greater experience allows them to retain greater risk.
While there has been a steady increase in the number of new formations in captives with workers' compensation as their primary line of business, the premium income generated by them has remained flat. As a result, captives with workers' compensation as their primary line of business consistently comprise 20% of total captives, but the percentage of premiums written by such captives has fallen from 25% to under 20% of total premium volume during the three year period.There has been a 40% increase in the number of companies providing property cover, with premium volumes having more than tripled since December 1996. Property captives now rank second behind healthcare captives in terms of premium written. Note that most of the SPVs set up to access the capital markets are included in this category.
In the nine months to 30 September 1999, a net addition of two products liability captives has been accompanied by an increase in related premiums written of $332 million. This increase is primarily due to one large new captive writing significant volumes of auto warranty business.
The percentage of total premiums contributed by companies with credit life as their primary line of business has declined from approximately 15% to below 5%.
The number of licenced captives has grown at a steady rate of between 7% and 8% per annum from 1996 through 1998.
• The net increase of 11 licenced captives in the nine months to 30 September 1999 shows weaker growth than in the past three years. However, as each of the last two years were record years not just in Cayman but worldwide, some decline in growth is not unexpected.
• In the period 1997 through 30 September 1999, there has been a 57% increase in gross premiums written through Cayman captives, with the largest increase occurring in the nine months to 30 September 1999, due mainly to the new product liability captive mentioned above.
Discussion of recent trends
The general perception within the Cayman Islands is that the core of Cayman's business has traditionally been single parent captives set up to provide the following:
• Medical malpractice and other healthcare related cover (see discussion under Healthcare below); and
• Traditional property/casualty (P/C) cover for small to middle market companies.
There is no consensus within Cayman's offshore insurance industry regarding the future of the traditional P/C captive. Some view this area as having been relatively unaffected by the soft insurance market (a view supported by the continued growth in pure captives over the past three years); others see it as being more and more susceptible to wider market conditions.
The general view is that growth in this area has been, and will continue to be, driven by small to middle market companies in the US, which have only recently been introduced to the captive concept. Significant new captive formations by large Fortune 500 type companies are generally seen as unlikely because (i) their purchasing power allows them to obtain the full benefits of the soft market and (ii) most already have a captive.
One manager has seen some smaller P&C captives moving from Bermuda to Cayman. The reasons given: lower cost as well as Cayman's more flexible legislation and approachable regulators.
Healthcare captives have long been at the heart of the Cayman captive offshore insurance industry. Trends over the past three years indicate that this is likely to continue. Some insurance managers are cautioning that growth in this area will be hampered by mergers and acquisitions in the US healthcare industry itself, which, it is assumed, will result in a rationalisation of risk management programmes, including consolidation of captives. Despite the strong growth in premium volumes in 1999 shown in the statistics, some managers are reporting slower growth in the number of new healthcare captive formations and, potentially, in reduced premium volumes through existing captives. However, other managers are still seeing new formations. The reasons:
• a fear that the market will harden;
• smaller hospital systems and groups of doctors coming to the captive market for the first time;
• the potential conversion of self insurance trusts to captives;
• the creation of a Cayman captive to accept a portfolio of existing business from another captive.
The advantages of captives over onshore self-insurance trusts are perceived to be greater flexibility in terms of investment policies and the use of funds within the captive (for example, profits can easily be dividended back to the parent for non-insurance uses). The latter two points are evidence of a general trend of rationalisation of existing risk management programmes, with run-off business being segregated from new business, for example, by way of loss portfolio transfers.
One of the most interesting developments in the last three years has been the use of Cayman domiciled and licenced SPVs to access the capital markets by securitising insurance and non-insurance risks. The growth in these types of vehicles throughout 1997 and 1998 appears to have tailed off in 1999. Again, views are mixed. Some interpret this apparent slowdown as an indication that, having demonstrated that such structures are a viable alternative to traditional reinsurance, the players involved have returned to the reinsurance market with a new bargaining chip. Others say that new structures continue to be developed, with existing structures being renewed.
Growth in the use of these types of structures is susceptible to:
• Uncertainty regarding future interest rates, which may impact the appetite in the capital markets for such risks;
• Actual losses causing investors to reassess the risks associated with them;
• Finer pricing from more traditional sources of coverage.
Nevertheless, the success of these structures to date indicates that, for big players, risk securitisation is now a truly viable alternative to the traditional reinsurance market and that Cayman has established a track record which will stand it in good stead over the next few years.
Segregated portfolio companies (SPCs)The advent of the SPC legislation, which was introduced in 1998, has triggered significant levels of interest in these entities. In summary, the new law permits the assets and liabilities of one cell to be segregated from those of other cells within the same company. If one cell becomes insolvent, its creditors only have recourse to the assets of the cell and any non-cellular (core) net assets of the SPC, in excess of the required minimum net worth of the SPC. It is important to note, however, that this concept has yet to be tested by way of due legal process.
The fourteen SPCs licenced to date have a total of 36 separately active cells. Some of these were conversions of existing rent-a-captives and association captives.
SPCs are being used for a variety of purposes, as follows:
• Rent-a-captive type SPCs:
In this scenario, a promoter will establish the SPC and make cells available to a wide range of third party users, with a view to earning fees for administering the business in the cells. Individual cells will typically not be capitalised. SPCs are well suited to the rent-a-captive type of structure because the cell user is protected from liabilities arising on other cell users' business.
• Association captive type SPCs:
As noted, SPCs are also being used for association captives, with some existing structures converting to SPCs to take advantage of the segregation of assets and liabilities. In structures of this type, individual cells will be capitalised and there may be an element of profit-sharing by the cell users.
The sharing of risks within individual cells is a consideration to achieve deductibility of premiums for US tax purposes. Several managers reported recent interest in these types of SPCs from US producers, agencies and brokers (see further discussion under Agency business below). Increased interest has also been noted from healthcare entities where cells can accommodate individual doctors or groups.
• Deferred variable annuity (DVA) and variable life product SPCs:
SPCs are now the vehicle of choice for life type products such as DVAs (see further discussion below). This is a significant potential growth area for SPCs.• Composites: companies writing both general and long term business:
• General use SPCs are used to place individual lines of business through separate cells, such that, for example, workers' compensation liabilities are segregated from property losses.
The main perceived advantage of SPCs over traditional captives is that the formation of a new cell should be quicker and less expensive than forming a new captive. Most managers do not expect there to be an adverse impact on pure captive formations; rather; the hope is that SPCs will attract incremental business to Cayman in the form of smaller players who otherwise would not have gone through the time and expense of setting up a captive.
Some captive owners are seeking to convert their “pure captive” to the SPC structure; their intention is then to write third party business (from within the owner's industry) into separate cells of the SPC.
Cayman is not alone in passing segregated cell legislation. Similar legislation exists in other offshore jurisdictions (such as Guernsey) and the National Association of Insurance Commissioners (NAIC) in the United States has agreed model protected cell company legislation. In future, Cayman can expect to have to compete for SPC business with other jurisdictions.
Deferred variable annuities and other life type products
An important development in the past three years has been the establishment of Cayman licenced companies offering DVAs and variable life products. DVAs and variable life products a specialised area in which Cayman appears to have established an increasingly strong market position. The development of these types of entities is not evident in the statistics because only a relatively small number of companies offer these products and premium volumes are not reported in the entity's own financial statements (and, hence, not included in the statistics).
Factors which have contributed to growth in DVAs and variable life products are:
• Favourable tax law precedent in the US allows policyholders potentially to defer capital gains on such policies; they are primarily used for retirement and estate planning purposes.
• The flexibility to allow a diverse investment strategy.
• The introduction of SPC legislation has created the perfect vehicle for life type policies. One cell is used to write one policy only, providing asset protection.
It is likely that variable life products will show more significant growth than DVAs in the future, as they are more efficient retirement and estate planning products. The CIMA reports that two new, highly capitalised life reinsurance companies have been established during 1999.
One manager reported interest in using a Cayman domiciled entity to issue life policies tied to annuities. If properly structured, such entities could achieve the same effect as an offshore trust but without the negative connotations - the benefits are tax deferral, a more flexible investment policy and no US securities law considerations (which would exist if a US domicile were used).
A clearly emerging trend has been the level of interest that insurance managers in Cayman have received from groups of US producers, including agencies and brokers, motivated by pressure on broker commission income, due to declining rates in the US insurance market. These groups are seeking to maintain or improve their profitability by cherry picking business they produce, i.e. taking a retention in selected pieces of quality client business. Interest is coming primarily from small to middle market players whose motivations also include a desire to protect their client base and to have access to new sources of management fees.Most interest from these groups, which include agencies producing medical malpractice business and mortgage guarantee cover, is in SPCs, with less interest in the traditional association type captive structure.
A line of business which has seen recent dramatic growth is warranty and extended warranty cover. The recent formation of several Cayman captives and reports of an increased level of inquiries indicate that Cayman is establishing itself in this sector, primarily because the regulators understand the business and are flexible in regulating it. The players involved tend to be large manufacturers and/or dealerships, although interest has also been received from smaller dealers.
Loss portfolio transfers
Another clear trend is a reported increase in interest in new formations designed to accept loss portfolio transfers from companies with a self-insured retention, insurance companies or other captives. One of the drivers in this business is merger and acquisition activity in the US. Other factors include the continuing reorganisation and rationalisation of risk management programmes and a desire to place old long tail business in run-off structures distinct from current insurance arrangements. SPCs are being considered as vehicles for accepting such loss portfolio transfers.
As shown on the following page, the sources of Cayman's captive business have been stable over the past three years. Over 80% of Cayman's captives provide cover for risks located in North America. Captives which provide cover for risks in the Caribbean and Latin America now comprise 11% of total captives, up from 8% at the end of 1996.
Several managers believe that the South American market offers Cayman an opportunity for significant growth, particularly as many of the leading South American (especially Brazilian) financial institutions already have some kind of presence in Cayman, which is in a similar time zone. To date, however, there is little evidence of significant growth from this market.
In our discussion with insurance managers, we asked them to identify what they perceived to be key drivers for growth in Cayman's captive offshore insurance industry, both in the short and medium term. Although the Cayman market is diverse and there is no clear consensus as to its likely future direction, there are certain broad perceptions.
The following were some of the common themes:
1. Hard/soft market
There is uncertainty regarding both the impact of the soft insurance market on Cayman and whether the cycle of the (re)insurance market softening and hardening will continue in the future.
A few managers believe that the steady growth demonstrated by Cayman in recent years in the face of a consistently soft market indicates that it has some degree of immunity from the state of the general insurance market, especially at the lower end of the market. A dampening of commitment to captives is not perceived - owners remember the hard markets.
The main view, however, is that while Cayman has had continued steady growth over the past three years, there are more and more signs that the soft market has had an impact in the number of new captive formations, the winding up of existing captives and in a reduction in premium volumes written in the more traditional structures.
Conversely, while the soft market may have slowed traditional captive formations, it has increased the number of agency-driven enquiries (see Agency business above).
The belief was expressed that the cycle of hardening and softening of insurance/reinsurance rates will be far less extreme in the future, for the following reasons:
• The blurring of the traditional divisions between the insurance and reinsurance markets;
• The purchasing power of big buyers of insurance (Fortune 500 type companies) and the significant influence they exercise over market rates;• Fewer, more sophisticated players in the (re)insurance market, with access to larger pools of capital, has increased capacity to the point that lower rates are being accepted to maintain market share.
Others argue that the hard/soft cycle still exists - it is just that the insurance market is less homogeneous than in the past, resulting in some sectors hardening while others soften.
A very recent development identified by some managers is the hardening of rates in the small to middle market in traditional property/casualty lines in the US, resulting in increased interest in traditional captive structures (as well as SPCs). The main reason: combined ratios in excess of 100% are regarded by insurance carriers as unsustainable given uncertainty regarding future investment returns. (see Macroeconomic factors below).
2. Macroeconomic factors
The impact, if any, of recent uncertainty as to future developments in the US equity market and uncertainty regarding US interest rates in the short to medium term have yet to be felt in the Cayman offshore insurance industry. Several managers are of the view that the squeezing of investment returns will result in US insurers returning to an emphasis on profitable underwriting to maintain overall profitability.
It is assumed that this will cause a hardening of rates in the traditional insurance market in the US, resulting in increased interest in the alternative market and, therefore, Cayman. Others argue that, for the reasons outlined above, a significant hardening of rates is unlikely.
A common theme arising from our discussions with insurance managers is that the new products/structures Cayman has to offer, especially SPCs, SPVs and DVAs, are currently driving interest in the domicile. This trend is expected to continue.
What is not yet known is whether this increased interest will actually result in a significant and sustained level of new formations.
4. Regulatory environment
The perception in Cayman is that the jurisdiction has been able to differentiate itself from its competitors through the flexibility of the insurance law and its application by the insurance regulators, while demonstrating an ability to regulate the industry effectively and, hence, maintaining the quality and reputation of the jurisdiction.
The prevailing view is that, while tax considerations are usually a factor in the decision to establish a captive in Cayman, they are not usually the key driver for turning to the alternative market in the first place. The main exception to this are DVAs, variable life products and other estate planning driven structures for family-owned businesses.
In summary, the trends identified in the insurance statistics have been borne out through our discussions with CIMA and the insurance managers. They are:• Continued reliance on the traditional core business of Cayman - single parent captives with an emphasis on smaller to middle-market companies and the US healthcare industry;
• High levels of interest in new structures/products (such as SPCs, SPVs, DVAs).
Our view is that Cayman must continue to be proactive in developing innovative new insurance products in order to sustain or exceed historical growth. However, Cayman will continue to rely heavily on growth in traditional captives (including healthcare), especially in the smaller to middle market sector. Cayman is well placed to take advantage of new business generated by any hardening of rates in this sector.
Rick Price agrees: “Cayman has shown resiliency and creativity in addressing the challenges posed by the soft insurance market and no doubt will continue to find resourceful ways to meet the needs of its clients.”
Paul Anderton and Rob Jenkinson are audit partners in PricewaterhouseCoopers' Cayman office. Between them, they have 35 years of experience in the offshore insurance industry. Charles Bolland is a senior audit manager who specialises in the captive insurance industry. The authors would like to thank the Cayman Islands Monetary Authority and the insurance managers interviewed for their time and valuable insights. The Cayman Islands firm of PricewaterhouseCoopers is a member of the worldwide PricewaterhouseCoopers organisation.