Insurance Post

Made to measure

Captive management and alternative risk transfer have developed almost beyond recognition since the concept of risk retention first became popular in the 1960s. As Ralph Savage discovers, each strategy is an individually tailored affair

According to ratings agency AM Best's Captive Directory, there are more than 5000 captive insurance companies formed in numerous locations around the world.

Their use is, in many ways, becoming the norm rather than the exception.

And with the insurance market claiming to be deadly serious that rates will never again reach the depths encountered during the 1980s and 1990s, captives are arguably becoming the corporate world's primary insurance layer. Lloyd's itself took more than a third of its £13bn premium in 2004 from reinsurance, while a similar figure is earned on excess and surplus lines business. The primary market may simply be too expensive.

But captives, and other forms of alternative risk transfer, are not only booming because firms want to avoid paying insurance premiums when the price gets too high. The captive insurance company is central to the core philosophy of risk transfer, and the corporate risk manager's task is becoming more and more a case of taking a long-term holistic view of company strategy, not just managing costs.

Put simply, Patrick Devine, partner at law firm Reynolds Porter Chamberlain, says: "ART is anything that is not conventional insurance. There's a general trend towards increased self-retention and that's reflected in the numbers of captive formations. It's been going through the roof."

Broking firms such as Aon and Willis have all adapted their own strategies alongside traditional insurance markets into providing ART consulting and captive administration to corporate clients. Meanwhile, international law firms are playing a major role in designing feasibility studies, looking at a company's business objectives and finding legal jurisdictions and captive domiciles to suit their needs.

The five most popular domiciles - Bermuda, the Cayman Islands, Vermont, Guernsey and Luxembourg - all offer established companies willing and able to administer captives. Couple this mature market with the diverse needs of global organisations and the sharp rise in insurance premiums after 11 September 2001, and it is not hard to understand why more and more domiciles have sprung up. These include Gibraltar and Malta, two domiciles that are winning significant business for their ability to passport insurance cover into the European Union, while maintaining the offshore advantages normally associated with captives.

EU passporting

The issue of passporting into the European Union is picked up by Stephen Cross, managing director of Aon Captive Services Group, who explains some of the basic motivations for captive formation. "There's the regional answer," he says. "If we see another series of hurricanes in the Caribbean, then a capacity withdrawal will happen and insurance prices will rise.

Indeed, had the tsunami occurred in a more industrialised area, self-retention might have been the only answer.

"Then there is the line of business answer," Mr Cross continues. "For example, the medical malpractice area in the US has a massive problem of very large exposures and very low insurance capacity. There is also the industry answer. You get very different levels of capacity for liability and if, say, a pharmaceutical firm wanted to conduct clinical trials in the EU, it needs insurance papers to do that. Therefore, lots of them have set up Malta or Dublin captives for that purpose."

Industries such as pharmaceuticals have unique risk profiles, as Mr Cross suggests. And Mr Devine adds that risk retention needs careful planning owing to the industry's complex short- and long-tail liabilities: "This is a good example of an industry that has large risks like any manufacturer - the usual perils such as fire and so on. But they've also got large product liability exposures and can suffer from class actions costing hundreds of millions of pounds. So such companies benefit from different ways of retaining risk."

Finally, Mr Cross points to a fourth - and most direct - driver towards increased use of captives over conventional insurance: major terrorism events. "Of course, you can get standalone terrorism cover at the moment but a dramatic event would change all that." He explains that in the aftermath of the attacks on the World Trade Center, corporates of a certain size that may already have retained around £5m of their own risk, saw fit to quadruple that figure because the market's prices had rocketed.


As alluded to before, the domicile of a company's captive or captives - there is no reason a corporate firm should have only one in operation - is of key importance and where it resides depends on what it is designed to achieve. Tax breaks are synonymous with offshore companies and investment strategies, but Martin Mankabady, a partner at law firm Lawrence Graham, warns against this: "If a corporate risk manager were to say to me that they wanted to set up a captive purely for tax reasons, I would say 'Think again'. There is no point in making a commitment like this for a tax break that may be here today but gone tomorrow.

"What's more, a parent company thinking of setting up a captive offshore may be subject to controlled foreign companies' rules in its home jurisdiction." Mr Mankabady explains that, unless the captive dividends up to its parent a certain amount of its distributable profits, which are then taxable in the home jurisdiction, part of the captive's profits will be treated as taxable at home.

Therefore, says Mr Mankabady, a checklist for a domicile needs to be compiled. "The issues to consider are: the relevant jurisdiction's operating convenience, for example how light or heavy the local regulator is; the cost of establishment of a captive and its administration; the local infrastructure, such as time difference, flight connections and existence of service providers; whether there is a sufficiently good pool of non-executive directors; and, finally, the overall perception of the jurisdiction in question."

Aon CSG operates its own protected cell captive called Whiterock, in which its clients participate by pooling resources while enjoying no liability to the losses of other members - this is a more recent approach developed as late as 1997. Whiterock has domiciles in Guernsey, Gibraltar, Malta and Luxembourg, and is shortly setting up shop in Bermuda. "Some of the planning assumptions can be up to seven years and typically the large captives last up to 20 years," explains Mr Cross, "but the most volatile area is in the first or second year of operation."

One of the great ironies surrounding ART is that insurance brokers are taking premium volume away from insurers by promoting captives. So would Aon CSG be cutting off its own nose if the market softens enough to source a hedge from the insurance market? "If some advantage can be made on a dollar basis, then it might be cheaper to go and buy insurance," says Mr Cross. "But I don't see the market softening too much on us just yet."

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