Insurance Post

Winner takes all

Captives have been shown to offer parent companies distinct advantages, including long-term cost savings and enhanced control but a complex combination of factors will dictate whether ownership is an appropriate option. Nevertheless, innovative developments continue to stoke interest in a market ripe with reinvention, as Ana Paula Nacif reports

With new DOMICILES springing up in both onshore and offshore locations as well as new offerings, the captives market is far from static. However, according to Aon's recent report Global 1500: A Captive Insight, the market remains underdeveloped, with 53% of the global 1500 companies not currently owning a captive.

The report, published in June, also argued that as a result of this underdevelopment, insurance buyers within the world's largest companies are failing to get better cover and save around 10% to 15% in costs.

It is well known that captives can offer their parent company many advantages, including retention of investment return on retained premiums, taxation efficiencies and improved risk management - not to mention savings on insurance costs. But setting up and owning a captive is not for everyone, and this could be why many companies have decided, for the time being, to stick with their conventional insurance arrangements in the open market.

"Anyone who should have a captive and doesn't have one may be losing out," reasons Dominic Wheatley, managing director at Willis Management (Guernsey). "However, it is dangerous to imply from particular market trends that people are not taking advantage of captive value available to them. There is a complex combination of factors - including industry sector, location and the structure of the parental organisation - which will influence a company's decision to establish a captive or not."

Andrew Tunnicliffe, group managing director, business development at Aon Global Risk Consulting, agrees that sweeping generalisations should be avoided. "The decision to set up a captive is the result of a combination of strategic, financial and operational issues. It is much more complicated than just looking into cost savings in the short term. And when we do feasibility studies for our clients, in some situations we actually recommend against it."

Holding back progress

There are other barriers as well. For example, certain industries and regions may not be as well developed in terms of risk management. So, while some sectors favour captives as part of their risk financing approach, others such as leisure and technology are still developing.

"If you look at specific industries some, such as heavy engineering or oil and gas extraction, have companies that have ranked as the world's largest for a long time," explains Mr Tunnicliffe. "They have history, a more mature understanding of their risk profile; they know when the insurance market will or will not respond to their needs and, therefore, they look to optimise their insurance purchase decision in a structured way."

There are also regions where risk management culture is still in its infancy and/or regulations have not yet been developed to create a favourable environment for captives. Despite that, Mr Tunnicliffe argues, "for most regions it is not a question of if but when. In other cases we also require cultural change. In part this is about client education and a developing sophistication in the client risk financing strategy."

Current market cost is one reason why some companies may be shunning the captives market. Jane Portas, director of general insurance, financial sector advisory, at KPMG UK, explains: "Our experience shows that corporates are looking closely at the cost of their insurance programmes and Aon's report could indicate that some companies are finding that they are able to place their business more effectively in the open insurance market, which is leading to innovation in new corporate insurance solutions."

But, according to Mr Wheatley, the fact remains that captive growth has been robust. "If you look at the figures, historically there has been a steady growth in captives through all phases of the insurance market cycle."

In fact, Miller Insurance Services conducted some research on captive use at the Association of Insurance and Risk Managers' conference in June and one fifth of the 100 risk managers surveyed said that, despite the softening market, they are choosing to retain more of their own risk. Risk managers also indicated that they want to assert greater control over the insurance cycle and one of the key tools to do this is through the use of captives.

Innovations in this market, such as Protected Cell Company and Incorporated Cell Company models, have also helped to retain the appeal of captives. Through these models, companies that are not prepared to embark on a full captive have options that are more flexible in terms of capital requirements and, in many cases, are cheaper to run.

"PCCs can offer significant structural advantages for parents in particular jurisdictions and where direct control is not an issue," explains Mr Wheatley. "They can also offer some cost benefits over conventional captives, although these are sometimes exaggerated."

Separate cells

PCCs, which were first offered in Guernsey in 1997, are a model made up of a core and individual cells. Legal segregation means that no claims against one cell can be covered with the funds of another. Going a step further, many jurisdictions now not only offer PCCs, but also have introduced ICCs. The latter type also has cells, but each one is a separate legal entity - adding an extra layer of protection in the separation of assets and liabilities.

Merise Wheatley, managing director of Health Lambert Insurance Management (Guernsey), explains that, while some large companies may have a range of self-insurance arrangements, small to medium-sized enterprises in particular can benefit from PCCs and ICCs. "They take less management time and these are easier to set up and exit. You do lose some control but, for smaller companies, this is probably not an issue."

Another strong trend that has developed over the past few years, according to David Blackburn, director of UK and European development at Miller Insurance Services, is that more professional services firms are setting up captives for their professional liability risks. "Another trend, in a completely different area, has been that of large property owners who offer insurance to their tenants. Instead of outsourcing, some of these companies are bringing the risks in-house."

The market is constantly evolving and Mike Allen, tax senior manager and UK captives specialist at KPMG UK, believes this innovation is likely to continue. "I don't think either the captive or conventional insurance markets stand still - they are continuously working to offer products to meet clients' needs," he says. "In terms of captive jurisdictions, they have the ability to change their legislation to be as amenable as possible to those who want to insure their risks."

This ability to change and adapt means that some domiciles are more suitable than others, according to the parent company's objective. Furthermore, a briefing by Marsh last December argued that there is increasing interest from owners in migrating captives from offshore to onshore domiciles. But it seems that the onshore/offshore debate is not a straightforward one. According to Aon's report, while onshore domiciles continue to grow in Europe, the popularity of offshore has not diminished.

"Really it depends on what the captive needs to do," explains Mr Tunnicliffe. "In my view, from a European perspective, there are three types of domicile: traditional offshore; onshore direct writing locations; and onshore direct writing locations with more of an offshore approach towards regulation and licensing. Clients have to select the best fit."

Fronting company

Generally speaking, companies with a captive outside of the European Union need to pay a fronting insurance company if they want to transact direct business. This applies especially to companies that are using their captives to cover risks over and above the traditional property and casualty risks, such as employers' liability.

"With an onshore captive you don't need to use a fronting company or pay for their services or provide them with collateral," explains Jonathan Groves, head of Marsh's captive advisory unit. "That gives companies more flexibility and freedom. Also, in onshore domiciles the regulatory and insolvency standards are higher. Therefore, companies need to do a cost-benefit analysis to see what best suits them."

And the introduction of Solvency II, with its stringent requirements, may well mean that some companies will look to migrate their captives elsewhere. Julian Cowburn, head of Airmic's captives group and group insurance manager at Old Mutual, says: "There are concerns about the possible detrimental impact on captives and their potential migration to other domiciles."

He adds: "There have been two studies, one by the Dublin Insurance and Management Association. It believes there could be problems with investment thresholds. Another study, by the European Reinsurance Managers' Association, found that capital requirement levels would be increased tremendously."

But while some locations have mature captives markets, such as Europe and the US, others, such as Central and Eastern Europe, are at early stages of development presenting potential for further growth.

Growing market

According to Aon's report, potential captive growth is greatest in Asia, where only 17% of Asian G1500 companies have captives - in Japan take-up is just 14%. But Mr Groves points out that this market is far from ready. "There is a lot of competitiveness in the Asian market, with local markets being very price-sensitive," he explains. "Generally the insurance programme is close to being ground up so when you approach the market to place a deductible of $500,000 (£245,425) or $1m, given the premium is already so cheap, the discount would be only small and it wouldn't make financial sense to retain that risk."

Nick Wild, head of JLT Captive Management and Consulting, agrees, adding that, despite the growing economy, a lot of Asian companies don't have a strong risk management culture. "They buy insurance in a decentralised way, subsidiaries don't buy insurance collectively. That in itself makes it difficult to apply the captive insurance model."

Regardless of how and where the captives market will realise its potential, many companies have already reaped the benefits. As Mr Blackburn concludes: "Captives are a long-term tool. Companies need to look three to five years ahead to realise savings, which can be considerably higher than 15%. People wouldn't do it if they didn't make money from it. Sometimes it can go badly wrong, but generally captives are quite successful."

LOCATION, LOCATION, LOCATION

The decision to set up a captive in an onshore or offshore domicile is not one to be taken lightly; but with a range of places to choose from, companies are certainly not stuck for choice.

Experts agree that the choice of domicile will depend on individual firms' requirements, but in Europe some places have been marketing themselves as the best of both worlds. Malta and Gibraltar are two examples of domiciles which, while benefiting from being EU-regulated, also offer benefits that have traditionally been exclusive to offshore locations.

"Malta and Gibraltar offer a combination of a captive-friendly style of regulation as well as the ability to issue policies on a direct basis throughout Europe," says Dominic Wheatley, managing director at Willis Management (Guernsey). "On the other hand, those looking for niche insurance may choose to go offshore to take advantage of the more flexible regulation available outside the prescriptive constraints of European directives."

If neither Malta or Gibraltar fits the bill, Andrew Tunnicliffe, group managing director, business development at Aon Global Risk Consulting, says that other domiciles such as Sweden, Ireland, and more recently Luxembourg and the Netherlands are potentially good locations for direct writing.

In the US, the largest onshore captive location is Vermont, says Mr Tunnicliffe, although there has been significant growth in Arizona, South Carolina and Hawaii.

He adds: "To demonstrate the point about clients' needs, users of onshore locations in the US are more driven by flexibility. For example, a captive in an onshore US domicile would be approved by the US Treasury to write terrorism cover, and by the Department of Labor to write employee benefits."

UK companies looking for a location may also have the tax man in mind. According to Mike Allen, tax senior manager and UK captives specialist at KPMG UK, "the tax authorities in the UK focus on tax avoidance and some groups feel that going down the captives route in some captive domiciles may send the wrong signals in terms of their tax compliance strategy".

With so many considerations, emerging domiciles will have to prove their worth if they are to get their share of business. But if they put the effort in, they shouldn't worry. "A lot of people say there is an oversupply of captive domiciles; I don't really agree with such comment," says Mr Tunnicliffe. "The subtlety here is that new and emerging domiciles do have an ability to capture market share if they take an innovative position on regulation. "If a new and emerging domicile recognises the next regulatory innovation and the demand for it, as long and as the domicile has appropriate infrastructure there is no reason why it will not grow."

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