From the time captives became commonly used as risk financing vehicles, people have been predicting their demise. Only the threats have changed.

Old battlefield

First, insurers tried to undermine the case for their formation. In the event, captives just got more and more popular, to a point where tax authorities became agitated and attempted to claw back the tax benefits that operating your own insurance company, particularly if located offshore, could generate. Both insurers and tax authorities won the occasional battle but they decidedly lost the war they had waged.

More recently, some commentators have suggested that captives have outlived their usefulness and the business case for continuance in an age of more sophisticated risk financing is no longer valid. Often these commentators are the same people who once did well out of promoting captives and, perhaps, are now looking for something new to sell. However, captive owners have been unimpressed by these arguments.

Irrespective of who has been attacking captives (and for whatever reason), their appeal to risk managers has not waned. Captives have proved to be largely immune to the insurance cycle (as it was once called). They have continued to be formed and their usage extended in all market conditions. There are no signs that saturation point has been reached or that the captive rationale is no longer compelling in the right circumstances.

The number of captives and their premium income have never stopped growing. For example, the Cayman Islands, the world's second largest captive domicile, expects 2000 to be a record year for new formations. Other locations also report buoyant activity.

Most captives are located “offshore” in jurisdictions that have actively sought this type of business. Typically, the offshore option delivers cost savings and a user-friendly regulatory environment. Although certain US states have enacted special captive regulations to gain a share of this market, approximately 85% of all captives are situated offshore.

But now it's serious

However, the term “offshore” has acquired a pejorative meaning in certain circles. The very existence of offshore financial centre (OFCs) is being called into question by the major industrialised nations of the world. And, while insurance is not generally a big part of the activities of OFCs, it has been caught up in this attack. In the last few months, therefore, captive business and how it is conducted and regulated have also come under a very intense spotlight.

Various international bodies, broadly following an agenda set by the G7 (now 8) nations, have charged OFCs with abusing their powers to set their own rules for financial services business. It is alleged that the regulation of these activities is usually deficient by international standards, either because the applicable controls are too weak or their enforcement is ineffectual.

These failings are deemed to be unacceptable for a variety of reasons. The Financial Stability Forum is concerned with threats to the international monetary system arising from capital flows that are driven (in part, at least) by the special features found in OFCs. The Organisation for Economic Cooperation and Development (OECD) sees OFCs as a conduit through which a part of the tax base of its members is being lost. And the Financial Action Task Force has categorised OFCs as the weak link in the fight against money laundering.

These different but overlapping agenda point to a concerted effort to restrict the opportunities for OFCs to continue to do business in the way to which they and their users have become accustomed. Many OFCs have found themselves described as “uncooperative” and placed upon one or more blacklists, with the threat of sanctions if matters do not improve to meet standards being set, it seems, by Washington and Brussels. The process of assessment is widely regarded as arbitrary (even, it is reported, within the OECD secretariat itself) and, certainly, it has not been based upon a careful and informed analysis of the actual practice of financial services regulation in the jurisdictions being named and shamed.

The areas in which action is being demanded mostly concern access to client information by the local authorities and the sharing of that information with counterparts in other countries. Secrecy (as distinguishable from confidentiality) will no longer be tolerated. For those OFCs where this has been the cornerstone of their financial industry a decline in business can be expected.

No hiding place

What does this mean for captives? The tax issue is now less material, given the common application of controlled foreign company provisions and such measures that dilute the benefits of being located in tax havens. As far as is known, there has been very little connection between captives and money laundering (in part thanks to the diligence of regulators who have declined several dubious propositions). Nevertheless, the insurance mechanism does lend itself to such activities as has been demonstrated in some conventional (ie non-captive) markets.

Regarding international financial instability, insurance probably has the best record of all financial sectors, with the captive experience being better still. In any case, in terms of potential threat, there are few captives that operate on a scale that would show on this particular radar screen. Indeed, only the collapse of the Bermuda market is a systemic risk that would count in this context.

However, in a sense this is irrelevant. OFCs are being judged in their entirety and exemplary insurance supervision will count for nothing if it is negated by shortcomings elsewhere. There is no intention to discriminate between different sectors, particularly when their boundaries are becoming more blurred.

To be acceptable, OFCs will have to adopt and enforce standards of regulation (including information access) that will be more onerous than currently applies and to standards that are higher than in any “onshore” jurisdiction. And cries of “unfair” will not be heeded. Can OFCs achieve this? Of course, and Cayman has already enacted most of the necessary changes. However, it will be more difficult for smaller OFCs that do not have the critical mass of business to diffuse the additional costs of supervision that will surely arise.


Out of adversity will come opportunity. Once OFCs are demonstrably world class jurisdictions, no longer open to the charges of secrecy or slack regulation, there should be no obstacle to their use. For OFCs that can attain this status (whereupon the “offshore” tag will be dropped), their share of international financial business should actually increase.

For the captive scene, the following developments may be expected.

  • There will be fewer OFCs that will be deemed acceptable and therefore the captive market might become more concentrated. That may be no bad thing if it serves to assure that all captives have access to a first rate service infrastructure. Captive services will become less of a commodity and more about added value.

  • On the other hand, captive ventures that are only viable “in special circumstances” may experience difficulties in finding a suitable home. Some risk financing structures may no longer be practical or economic.

  • Competition between domiciles (already more ritualistic than real) will be less important than the choice between onshore and offshore. A most interesting question will be whether the special provisions currently offered by some onshore locations (eg certain US states) will continue to be acceptable in this new world of level playing fields.

    In any event, having forced OFCs to “clean up their act”, there can be no criticism for using them. The result could be that, in future, more than 85% of the captive market will be offshore.

    Conspiracy theorists join here

    There is little doubt that these challenges to OFCs are part of a political crusade by the big nations. Some believe that the end game is nothing less than the extinction of OFCs, and the battle has hardly begun. As one set of tests is introduced and passed, so other more demanding criteria will be applied. In this scenario, the OFCs will always be found wanting and facing ever more draconian sanctions. However, the economic distress this would cause would have a political price that the G8 is unlikely to find palatable. Also, there may come a point when some of these directives and ensuing penalties will be challenged in the international courts.

    Whatever the speculation, Cayman for one is looking forward to continuing growth in its captive sector, for which it is already preparing.

  • Clive Thursby became head of insurance with the Cayman Islands Monetary Authority in January 2000. For the previous 24 years, he was an international risk management consultant, based in London. He is a Fellow of the Institute of Risk Management, of which he has also been a governor.

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